er (CIAT) Neil Palm Making Climate Finance Work in Agriculture Discussion Paper Department for International Development from the British people Making Climate Finance Work in Agriculture Discussion Paper Department for International Development from the British people Standard Disclaimer: This volume is a product of the staff of the International Bank for Reconstruction and Development/ The World Bank. The findings, interpretations, and conclusions expressed in this paper do not necessarily reflect the views of the Executive Directors of The World Bank or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. 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CONTENTS Acknowledgments v Acronyms and Abbreviations vii Overview ix Chapter 1 Agriculture and Climate Change 1 Agriculture: Part of the Problem, Part of the Solution 1 A Unique Opportunity to Leverage Climate Finance for Agriculture 3 Notes 4 Chapter 2 Financing Climate-Smart Interventions in Agriculture 5 Traditional Constraints on Financing for Agriculture 5 The Main Barriers to Lending to Agriculture 6 How Climate Finance Relates to Agricultural Finance 9 Scope of Climate Finance 9 Overview of Climate Finance Architecture 11 Role of Climate Finance in Agriculture 12 Barriers Preventing Climate Finance from Flowing into Agriculture 13 Notes 14 Chapter 3 Leveraging Climate Finance to Make Agriculture Part of the Solution 15 Innovative Ways to Attract Additional Capital to Agriculture 16 Climate Finance Entry Points into Agriculture 18 Improving the Enabling Environment 19 Risk Management Mechanisms 23 Mechanisms to Reduce Transaction Costs 32 Technical Assistance to Increase Investments in Agriculture 34 Technical Assistance to Lenders 34 Building Borrower Capacity 36 Notes 37 Chapter 4 Conclusion and Way Forward 39 References 41 iii iv Making Climate Finance Work in Agriculture Boxes 2.1 From Financing Agriculture to Financing Climate-smart Investments in Agriculture 9 2.2. “Climate Finance” in this Paper 9 2.3 The Global Agriculture and Food Security Program (GAFSP) 12 3.1 Peru Case Study: Global Canopy Program – Unlocking Forest Finance 18 3.2 The eco.business Fund Case Study 19 3.3 Ecuador Case Study: Credit Bureaus for the Rural Poor 24 3.4 Ethiopia Case Study: Farmers Access Finance Through Credit Guarantee Services 25 3.5 Kenya Case Study: Input-linked Weather Insurance – Syngenta Foundation and UAP Insurance 27 3.6 India Case Study: Value Chain Finance – HDFC Bank 29 3.7 India Case Study: Warehouse Receipt Financing – HDFC Bank 29 3.8 Philippines Case Study: Climate-smart Rice Cultivation through Phone Apps 30 3.9 Big Data Case Study: Reaching Smallholders with Alternative Credit Assessments 31 3.10 Pakistan Case Study: Branchless Banking – United Bank Ltd. 33 3.11 Kenya Case Study: Mobile Banking – M-PESA and M-KESHO 34 3.12 Cambodia Case Study: Building Agricultural Lending Skills – Amret Microfinance Institution and the World Bank 35 Figures 2.1 Key Barriers to Lending 7 2.2 Risk Profiles along the Agricultural Value Chain 8 3.1 Multiplier Effect of PPPs 16 3.2 Examples of Layered Capital Structures 17 3.3 Sample Finance Model for Finance in Motion 18 3.4 Example of a Climate-smart Investment Facilitator and Climate-smart Incubator 21 3.5 Example of a Climate-smart Investment Facilitator and Climate-smart Incubator 22 3.6 Portfolio Tranching to Segment Risk Types 26 ACKNOWLEDGMENTS Making Climate Finance Work in Agriculture is Warner (Senior Natural Resources Management the outcome of a collaborative approach between Specialist, WB) kindly peer-reviewed the discussion the World Bank (WB) Global Practice for Food paper and provided very insightful suggestions. The and Agriculture; the CGIAR Research Program on team is also grateful to David Howlett (DFID), Leslie Climate Change, Agriculture and Food Security Lipper (FAO), and Astrid Agostini (FAO) for their (CCAFS); and the U.K. Department for International valuable contributions. Development (UK DFID). A wide range of people and organizations in This discussion paper was prepared by a team the agriculture, climate and finance sectors gener- led by Marc Sadler (Global Lead for Climate Smart ously contributed case studies and valuable inputs; Agriculture, WB), and comprising Alberto Millan among them were Jamie Anderson (CGAP), Michael (Agricultural Specialist, WB), Stacy A. Swann Andrade (HDFC Bank, India), Simone Bauch, Josh (Consultant), Ioannis Vasileiou (Agricultural Gregory and Alexandra Pinzon (Global Canopy Specialist, WB), Tobias Baedeker (Agriculture Programme), Eric Cochard (Credit Agricole), Economist, WB), Roy Parizat (Senior Economist, WB), Lauren Hendricks and Dorcas Robinson (CARE Leah Arabella Germer (Consultant), and Friederike USA), Aitor Ezcurra (IFC), the WB GAFSP Team, Mikulcak (Junior Professional Officer, WB). Brian Milder and Elizabeth Teague (Root Capital), The team is also grateful to Preeti Ahuja (Practice James Rawles (CCAFS), Elena Yunatska (Finance in Manager, WB) for her valuable guidance and sup- Motion), and Dan Zook (Initiative for Smallholder port. Kruskaia Sierra-Escalante (Head, Climate Finance). Change Blended Finance, IFC), Panayotis N. Varangis This work was funded by the World Bank, the (Global Lead for Agriculture Finance and Agriculture CGIAR Research Program on Climate Change, Insurance, WB), Juan Buchenau (Senior Financial Agriculture and Food Security (CCAFS), and with Sector Specialist, WB), and Christopher James UK Aid from the UK Government. v ACRONYMS AND ABBREVIATIONS AFOLU Agriculture, Forestry, and Other Land Use ATM Automated Teller Machine BDSC Big Data, Small Credit CBO Congressional Budget Office CDM Clean Development Mechanism CCAFS Research Program on Climate Change, Agriculture, and Food Security CEDISA Centro de Desarrollo e Investigación de la Selva Alta CIF Climate Investment Fund CFC Cooperative Finance Corporation COP Conference of the Parties CPI Climate Policy Initiative CSA Climate-Smart Agriculture DFI Development Finance Institution DFID Department for International Development, U.K. FI Financial Institution GAFSP Global Agriculture and Food Security Program GCF Green Climate Fund GDP Gross Domestic Product GEF Global Environment Facility GHG Greenhouse Gas GIIF Global Index Insurance Facility ICT Information and Communications Technology IFC International Finance Corporation IFI International Finance Institutions INDC Intended Nationally Determined Contribution IPCC Intergovernmental Panel on Climate Change MDB Multilateral Development Bank MNO Mobile Network Operator NDC Nationally Determined Contribution NGO Nongovernmental Organization OCT Over-the-Counter Transaction OECD Organisation for Economic Co-operation and Development POS Point of Sale PPCR-CIF Pilot Program for Climate Resilience, Climate Investment Fund vii viii Making Climate Finance Work in Agriculture PPP Public-Private Partnership REDD+ Reducing Emissions from Deforestation and Forest Degradation SCCF-GEF Special Climate Change Fund (SCCF) of the Global Environment Facility SDG Sustainable Development Goal SME Small and medium enterprise SOFA FAO State of Food and Agriculture report UFF Unlocking Foreign Finance project UN United Nations UNFCCC United Nations Framework Convention on Climate Change USAID United States Agency for International Development VCF Value Chain Finance WB World Bank OVERVIEW at least 50 percent more food to feed nine billion This discussion paper was produced as a back- people. Climate change adds significant challenges to ground document for the 2016 FAO State of Food and this already perilous situation. Agriculture (SOFA) report. It is based on in-depth anal- However, agriculture in developing countries can ysis of the agriculture and climate finance literature, as well as interviews with key experts representing offer a pathway to economic development and inclu- various stakeholder groups in the agriculture, climate, sive growth. Recently the Economist estimated that by and finance sectors. The interviews were conducted in 2030, with the right policies and investments, agri- order to identify those opportunities and innovations culture could unlock an extra US$2 trillion in rural that should be explored to make climate finance work growth. Much of the growth could benefit smallholder for agriculture. Innovative and successful examples farmers in developing countries where, especially in of current efforts by the climate finance community Africa, agriculture is likely to be the main source of to reach agriculture have been provided by a range of people’s livelihoods for the next several decades. To relevant stakeholders. This discussion paper explores the intersection realize the opportunities agriculture has to offer, the between climate and agriculture finance by promoting sector needs to be transformed so it can deliver more dialogue about these topics and suggesting innovative sustainable agriculture and smallholder farmers can approaches. Exploration of this intersection is rela- access markets and become successful and profit- tively new, and the interventions explored here either able while also delivering food and nutrition security. are being tested or could be tested to increase the Here, agriculture has the potential to become: leverage of private capital and strengthen the links of financial institutions (FIs) with smallholder farmers and •• A thriving and successful sector that creates jobs small and medium enterprises (SMEs). Because the objective is to generate discussion, no blanket recom- and provides economic and livelihood benefits; mendations or descriptive interventions are proposed. •• A resilient sector that can successfully manage the climate risks of today and tomorrow; and •• A sustainable sector that minimizes its environ- mental impacts. Today a growing population and changing diets are driving an increased demand for food. Moreover, taking the right action on agriculture can Production is struggling to keep up as crop yields also help to significantly empower women, because at level off in many parts of the world, ocean health least 70 percent of women in South Asia and 60 per- declines, and natural resources—such as soils, water, cent in Sub-Saharan Africa work in agriculture. and biodiversity—are stretched dangerously thin. Climate change and agriculture are critically One in eight people suffers from chronic hunger and interrelated. Agriculture is extremely vulnerable more than one billion people are undernourished. to climate change: the sensitivity of crops, live- The food security challenge will only get more dif- stock, and fisheries to temperature, water availabil- ficult because by 2050 the world will need to produce ity, and extreme weather events puts yields at risk, ix x Making Climate Finance Work in Agriculture jeopardizes historical productivity gains, and exposes •• Inadequate enabling environments; farmers to significant hazards. Because yields affect •• Insufficient capacity to manage exposure to spe- their incomes, food security, and livelihoods, farmers cific agricultural risks; and are the first to be confronted with the perils associ- •• High transaction costs. ated with climate change impacts on agriculture. Yet agriculture also contributes to climate change; These continue to limit the access of farmers to it accounts for 19 to 29 percent of total greenhouse working capital (short-term loans) and more impor- gas (GHG) emissions and emits the largest share tantly to investment capital (longer-term loans), of non-CO2 GHGs. Thus, farmers and other actors making it difficult for them to invest in the value- across the agricultural value chain have a crucial role adding infrastructure that could dramatically raise in achieving a global climate solution. their productivity and incomes. These barriers also Fortunately, research has shown that climate limit the access of smallholder farmers and SMEs to change adaptation and mitigation in the agricultural a broad range of other tailored and demand-driven sector are feasible both technically and economically. financial services. According to the Initiative for Agriculture is thus prominent in the recent Paris Smallholder Finance, total smallholder financing Agreement, the Intended Nationally Determined demand in Latin America, Sub-Saharan Africa, and Contributions (INDCs), and the Sustainable South and South East Asia is estimated at $210 bil- Development Goals (SDGs). lion (Dalberg 2014). With 75 percent of the world’s Specifically, the outcomes of the December 2015 poorest people located in rural agricultural areas, Conference of the Parties (COP21) to the UNFCCC this gap is a severe impediment to poverty reduction. in Paris, laid a solid foundation for global action to Despite agriculture’s vulnerability to climate adapt and mitigate the effects of climate change on change, the total amount of climate finance allocated agriculture. The majority of the INDCs include agri- in 2014 to agriculture, forestry, and other land-use culture in their mitigation targets or reference agri- was disproportionally small at US$6–8 billion, con- culture as an adaptation priority. Those ambitions are sidering that the total amount of climate finance also tightly linked to many of the SDGs, particularly mobilized globally that year was US$391 billion. SDG 1 (no poverty), SDG 2 (zero hunger), and SDG Among the factors responsible for the shortfall are 13 (climate action). Still, in most cases cost estimates imbalanced risk-reward profiles for investments and adequate financial mechanisms have yet to be in the sector, limited capacity to identify financial specified. Equally critical to achieving these adapta- needs for adaptation and mitigation purposes in tion and mitigation objectives is significantly increas- agriculture, an evidence base that is insufficient for ing the amount of capital available for climate-smart identifying the most suitable climate-smart practices investments in agriculture, which will require over- and technologies, a lack of adequate metrics and coming long-standing institutional barriers. tools to accurately measure the impact of climate- The need for additional liquidity in agriculture smart interventions, and a fragmentation of climate is not new. Access to sufficient and adequate finance finance resources. has been a challenge for agriculture in developing However, climate finance can be instrumental in countries for decades. Due to perceptions of its low supporting the agriculture sector to become part of profitability, low margins for financiers, and high the climate solution. This discussion paper proposes actual and perceived risks (among other issues) three avenues for making this happen: financiers in most countries limit their exposure, raise interest rates, tighten lending criteria, shorten 1. Design innovative mechanisms and adapt oth- terms, impose onerous lending terms, and often shy ers to leverage additional sources of both public away from lending to agriculture at all, seeking more and private capital that can be directed toward stable returns from other sectors of the economy. climate-smart investments in agriculture. This This finance shortfall is a major problem for small- discussion paper discusses such mechanisms as: holder farmers and SME agribusinesses, particularly •• Enhancing public-private partnerships to for women, who have the least access to finance. leverage the resources, expertise, and capacities Three of the major barriers that have traditionally of different stakeholders; limited the access of smallholder farmers and SMEs •• Designing and piloting new investment vehi- to sufficient and adequate finance are: cles that can attract additional capital by Overview xi diversifying, managing and rebalancing the tailored financial instruments and develop new risk return profiles of individual investors; and delivery channels that meet the needs of those •• Bundling a wide range of financial instruments smallholder farmers and SMEs engaged in cli- to heighten their effectiveness and provide mate-smart practices. Moreover, financial and more holistic and comprehensive solutions. technical support could be contingent upon achieving specific climate-smart outcomes, so However additional investments alone will that FIs specifically promote such investments not be effective. The entrance of climate finance after an earlier technical assistance program. into agriculture will be impeded by the same old To achieve this, it will be crucial to increase the constraints unless they are addressed while also capacity of both FIs and farmers. To that end, the achieving positive climate outcomes. To ensure third avenue for using climate finance explored that additional capital is effective, it is essential to here would be crucial. strengthen the currently tenuous links between FIs and farmers. To that end, the second avenue to 3. Provide technical assistance to increase invest- using climate finance discussed here will be critical. ments in agriculture. Public climate finance could play a useful role in helping to strengthen 2. Identify entry points, for directing climate finance the capacities of the main stakeholders engaged into agriculture and linking financial institu- in climate-smart investments, namely lenders tions smallholders and agricultural SMEs. Public and borrowers. sources of climate finance are uniquely positioned to address some of the financial sector constraints •• Lenders on agriculture and thus significantly increase the •• Build institutional agricultural finance flows of capital to smallholder farmers and SMEs. capacities For instance, climate finance could be used for: •• Build the capacity of agricultural finance staff •• Developing and improving a finance-enabling •• Customize financial products and services environment for agriculture: The basis could to agriculture be better policies and regulations to mobilize •• Borrowers and channel financial flows to farmers and to •• Adopt on-farm climate-smart practices and build the structures to facilitate and accelerate technologies climate-smart and other investments; •• Manage risks •• Supporting FIs to develop and reinforce their risk •• Access finance management mechanisms: Possible options are to establish rural credit-rating agencies, and Finally, this discussion paper presents several sug- promote guarantees, insurance, value-chain gestions for achieving the ideas presented, such as: finance, warehouse receipts, climate-smart advi- sory services, and big data and data science; and •• Increasing knowledge about innovative and •• Supporting FIs to reduce transaction costs: demand-driven financial instruments and Branchless banking and mobile financial mechanisms; services are the most obvious of numerous •• Bridging information gaps; options. •• Identifying opportunities; •• Promoting dialogue and cooperation; and These interventions could significantly help FIs •• Designing an action plan to move the agenda to enhance their capacity to design and provide forward. Chapter 1 AGRICULTURE AND CLIMATE CHANGE extreme weather, drought, flooding, and other disas- Key Messages: ters.” SDG2 specifically calls for doubling the pro- ductivity and incomes of small-scale food producers, • Agriculture is particularly vulnerable to climate particularly women farmers and other vulnerable change, and farmers bear some of the most sig- groups. SDG13: Climate Action, has as an objective nificant risks. However, agriculture is also a major to “promote mechanisms for raising capacity for contributor to climate change, and can therefore effective climate change-related planning and man- be part of the climate solution. • Agriculture features explicitly in the Paris Agree- agement in least developed countries … including ment, INDCs, and SDGs. The Paris Agreement and focusing on women, youth and local and marginal- INDCs have set ambitious goals for mitigation and ized communities.” Similarly, SDG1: No Poverty, adaptation that cannot be attained without agri- aims to “build the resilience of the poor and those culture playing a major role. in vulnerable situations and reduce their exposure • Agriculture is central to building resilience to cli- and vulnerability to climate-related extreme events.” mate change. Adaptation- and resilience-oriented Given that agriculture is the main source of income agricultural interventions can also yield mitigation for 70 percent of the world’s poor (WB 2016), a low- and broader development co-benefits, although these cannot be attained if agriculture continues emissions, climate-resilient agricultural sector will be to do business as usual. critical to eliminating global hunger and poverty. • Research and practice have shown that agricul- tural adaptation and mitigation are technically and Agriculture: Part of the Problem, Part of the economically feasible, and that there are mature and scalable technologies and management meth- Solution ods already available. Progress toward achieving the SDGs will be impeded • It is crucial to quantify accurately the costs and by the fact that agriculture is extremely vulnerable financial requirements for climate adaptation and mitigation interventions in agriculture and to build to climate change. Due to the sensitivity of crops up the existing financing, instruments, and mecha- and livestock to temperature, water availability, and nisms to support such interventions. extreme weather, climate change threatens agricul- tural production and therefore heightens the vulner- ability of people dependent on agriculture (Lipper et al. 2015). Smallholder farmers—the vast major- To achieve the UN SDGs, agriculture must be part of ity of farmers in developing countries—are among the climate solution. By 2030, SDG2: Zero Hunger, the most vulnerable because they have little capacity aims to “ensure sustainable food production systems to adapt, lack safety nets, and are highly exposed to and implement resilient agricultural practices that livelihood and food-security risks. The vulnerabil- increase productivity and production, [and] that ity of agriculture to climate change also threatens strengthen capacity for adaptation to climate change, global resilience to climate change more broadly, 1 2 Making Climate Finance Work in Agriculture because agricultural production plays a central role doubled over the past 50 years, and may increase 30 in numerous dimensions of food security, such as percent more by 2050 (Tubiello et al. 2014). food availability, the stability of food supplies, access Numerous technically feasible mitigation inter- to food, and food utilization (Schmidhuber and ventions have been identified for agriculture, among Tubiello 2007). them sustainable livestock intensification, changes in Over the past few decades, a range of technically rice production, agroforestry, and carbon sequestra- feasible interventions has been identified to help tion. Smith et al. (2007) found that carbon seques- agriculture adapt to climate change. Most adapta- tration in cropland, grazing land, and rangeland soils tion options build on existing practices in sustain- is the greatest potential source of climate change able agriculture (Jarvis et al. 2011); full adaptation mitigation in agriculture. Primarily due to less defor- to global, climate-related losses in food availability estation and more carbon sequestration, net GHG is technically possible (Vermeulen, Campbell, and emissions due to land use change and deforestation Ingram 2012). On the farm, a diversified mix of are estimated to have dropped by 10 percent between crop and management methods, better use of cli- 2001 and 2010 (Tubiello et al. 2014). This suggests mate forecasting, management of climate risk, and that reducing agriculture-driven deforestation is an financial instruments to support these activities can important mitigation option for agriculture as well. enable successful adaptation. At the global, regional, Because net annual baseline CO2 emissions from and national levels, a number of studies have com- agriculture, forestry, and other land use (AFOLU) bined models of climate, crop yields, and global are projected to decline, these sectors together could trade to estimate and help mitigate climate impacts become a net CO2 sink before the end of the century on incomes and food security. Such modeling is (Edenhofer et al. 2014). Finally, done sustainably and important for evaluating the food security trade-offs efficiently, bioenergy production can be a viable mit- of various adaptation options. igation option (Edenhofer et al. 2014). Synergies between food security, adaptation, and It is now much clearer how GHG sources and mitigation have also been found to make agricul- sinks operate. Because more accurate data are now tural adaptation interventions economically feasible available on agricultural processes as emitters and (Vermeulen et al. 2012). Agricultural adaptation on the geographies of agricultural emissions (FAO avoids the opportunity costs of inaction, and cor- 2014), it is much easier to identify those mitigation rectly timing investments can maintain produc- options that can do the most to reduce emissions tivity growth. Some adaptation options also offer from agriculture. A recent study by the Climate and “no-regret” solutions, in that they contribute to food Land Use Alliance (CLUA) found that it is possible to security and resilience without requiring trade-offs reduce annual carbon emissions from global agricul- for mitigation (Nelson et al. 2012). In fact, broad- ture by as much as 50 to 90 percent by 2030 (Dickie based agricultural adaptation has been found to have et al. 2014). mitigation co-benefits that are less expensive than Numerous mitigation interventions in agriculture many activities designed primarily for mitigation have also been found to be economically feasible. (Lobell et al. 2013). Mixed crop-livestock systems are According to a recent OECD review of studies of the one type of adaptation practice that has co-benefits cost-effectiveness of mitigation measures in agricul- for mitigation (FAO 2013). ture, a set of often-considered, highly cost-effective In addition to being vulnerable to climate change, mitigation measures and enabling policies is emerg- however, agriculture is also a significant contributor ing globally (MacLeod et al. 2015). In this context, to it. While estimates of agricultural emissions vary, the IPCC Fifth Assessment Report (AR5) identifies recent data suggest that agriculture accounts for 19 cropland management, grazing land management, to 29 percent of total anthropogenic GHG emissions and the restoration of organic soils as the most cost- (Vermeulen et al. 2012). Moreover, agriculture emits effective mitigation options. Finally, many of these the largest share of any sector of non-CO2 GHGs (54 options are not only cost-effective, but have adapta- percent in 2005) and is expected to remain in the tion and resilience co-benefits as well. lead through 2030 (EPA 2012). Non-CO2 emissions, Given the critical links between agriculture and such as methane and nitrous oxide, have a far greater climate change, as well as the copious evidence that per-ton warming effect than CO2. Indeed, emissions climate change interventions in agriculture are tech- from agriculture (including forestry) have nearly nically and economically feasible, agriculture must Agriculture and Climate Change 3 become part of the climate solution. Indeed agricul- ture has recently been prominent in UNFCCC and Twenty-nine parties mention climate-smart agricul- ture (CSA) in their contributions. CSA is a concept climate finance discussions. However, financing for that encompasses a set of contextspecific agricultural adaptation and mitigation interventions in agricul- practices through which productivity is increased sus- ture is still minimal. tainably and climate adaptation and mitigation objec- tives are achieved (Richards et al. 2016). A Unique Opportunity to Leverage Climate Finance for Agriculture Within the UNFCCC negotiations, the COP21 in targets for agriculture. Moreover, 138 parties include December 2015 recognized that agriculture is both adaptation in their INDCs, and 127 of these (about critically affected by and a significant contribu- 67 percent) refer to agriculture as an adaptation pri- tor to climate change. In both the Paris Agreement ority. It appears from an early analysis of INDCs in and the INDCs,1 the need for adaptation and miti- December 2015 that the parties also recognize the gation interventions in agriculture is explicit and links between mitigation and adaptation, especially prominent. in the agriculture and land use sectors, with 44 men- The Paris Agreement explicitly links food pro- tioning the mitigation co-benefits of adaptation duction and food security to its objectives. It aims to actions or vice versa (Richards et al. 2016). “strengthen the global response to climate change, in While COP21 outcomes lay a foundation for the context of sustainable development and efforts global action on adaptation and mitigation in agri- to eradicate poverty” (UNFCCC 2015) and its pre- culture, there is a shortage of finance and other amble recognizes “the fundamental priority of safe- forms of support for the necessary interventions. guarding food security and ending hunger, and the For example, while the majority of INDCs do men- particular vulnerabilities of food production systems tion agriculture, few include specific financing to the adverse impacts of climate change.” Article 2.1 requirements for agricultural adaptation and miti- of the agreement, which sets out the target to limit gation interventions. Of the 189 parties that had the rise in global average temperature to well below submitted INDCs by May 2016, only 20 specified two degrees Celsius above pre-industrial levels and the financing requirements for agricultural adap- “pursue efforts” to limit it to 1.5 degrees, emphasizes tation (Richards et al. 2016). Most of those parties the need to reduce emissions “in a manner that does are African, and only two countries account for not threaten food production” (UNFCCC 2015). over 75 percent of these financing requirements. The agreement also acknowledges the importance of Only 22 parties specified financial instruments for human rights, gender equality, ecosystem integrity, agricultural adaptation support, such as insurance, and biodiversity protection—all issues that are cen- credit, and microfinance (Richards et al. 2016). As tral to agriculture (Meadu et al. 2015). for mitigation, only 17 parties set out in their INDCs Crucially, the data demonstrate that it will be the costs associated with their agricultural and land impossible to limit the global average tempera- use mitigation measures and actions. Moreover, ture rise to the two degrees Celsius mandated by many of the cost estimates are conditional, mean- the Paris Agreement without reducing emissions ing that the country will require international sup- from agriculture (Meadu et al. 2015). With the two- port to cover the costs of mitigation (Richards et al. degree target, viable options for reducing emissions 2015). Regarding financing mechanisms available from the industrial, transport, and energy sectors to address these issues in agriculture, the INDCs will likely run out by 2050, so that reducing agri- identify only a few, and few parties specify concrete cultural emissions is imperative (Campbell 2015). actions for the private sector. Reaching a 1.5-degree target will demand sub- In fact, the funds required for INDC agriculture stantially greater mitigation efforts, and thus more adaptation and mitigation interventions far surpass urgent agricultural measures (Meadu et al. 2015). the funds that have been pledged for this purpose. Agriculture is also included in the majority of An initial analysis of INDCs in December 2015 con- INDCs. All 189 parties that had submitted INDCs by cluded that considerable additional financing will May 2016 (Richards et al. 2016) include mitigation, be necessary to achieve the climate targets for agri- and 119 of them (about 63 percent) have mitigation culture that less-developed countries have set out 4 Making Climate Finance Work in Agriculture (Richards et al. 2015). Due to the limited data in With the appropriate tools and financial instruments, country submissions, financial projections based on investors can increase the small proportion of total the INDCs may be underestimated. However, the ini- climate finance currently flowing to agriculture (CPI tial projections already surpass current commitments 2015) and provide the support necessary for agricul- to climate finance for agriculture, and the annual ture to both mitigate and adapt to climate change; estimates are significantly higher than the amount to achieve that, public finance can act as a catalyst in multilateral climate funds have spent on agricultural leveraging private finance. Closing the financing gap projects in the last decade (Richards et al. 2015). will also require dealing with traditional barriers to Estimates in the literature also vary considerably; for agricultural finance in general, especially the aspects instance, for the global cost of agricultural adapta- of those barriers that make it particularly hard to tion alone, Nelson et al. (2009) estimated US$7 bil- attract climate finance. lion a year up to 2050 and Wheeler and Tiffin (2009) estimated US$12 billion a year up to 2030. Notes With agriculture increasingly being recognized as 1. Intended Nationally Determined Contributions a major part of the global climate change problem, (INDCs) become Nationally Determined Contributions public funders and private investors have a unique (NDCs) once parties to the UNFCCC deposit an “instru- opportunity to close the climate finance gap while ment of ratification, acceptance or approval” of the Paris making agriculture a part of the climate solution. Agreement. Chapter 2 FINANCING CLIMATE-SMART INTERVENTIONS IN AGRICULTURE for decades. Traditionally, a much smaller share of Key Messages: the financial sector loan portfolio has gone to agri- culture than to other sectors, especially compared • Access to sufficient and adequate finance for agri- to agriculture’s share in GDP. Due to perceptions culture traditionally has been, and continues to be, of its low profitability, low margins for financiers, a significant challenge for SMEs and smallholder high actual and perceived risks, and high transac- farmers, in particular women who are dispropor- tion costs, (among others) financiers in most coun- tionally affected. • Longer-term investment capital is needed so that tries limit their exposure to agriculture, raise interest smallholder farmers and SMEs can invest and rates, tighten lending criteria, shorten terms, require grow their businesses. other lending conditions, and often avoid lending to • The three main barriers to lending for agriculture agriculture, seeking more stable returns from such are (1) Inadequate enabling environments; (2) lack sectors as trade, housing, and energy. The resulting of capacity to manage exposure to specific agricul- financing shortfall severely impacts the agriculture tural risks; and (3) high transaction costs. sector, both farmers and SME agribusinesses. • Climate finance can act as a catalyst to (1) unlock In this discussion paper, agricultural finance1 refers additional sources of finance, specifically private capital; (2) tighten the links between FIs and small- to the provision of financial services to smallholder holder farmers and SMEs; and (3) provide techni- farmers and SMEs engaged in activities related to cal assistance to build the capacities of everyone agriculture. It encompasses a vast range of lenders, involved in the financial ecosystem. borrowers, and services. Among those engaged in • Additional barriers to the entry of climate finance financing agriculture are banks, nonbank FIs, micro- into the agriculture space are, among others, finance institutions, value chain actors (which have (1) difficulty in demonstrating short-term “quick a major role in agricultural finance), aggregators, wins;” (2) limited capacity to assess adequately and social lenders. Among recipients are smallholder what is needed to finance adaptation and miti- gation; (3) the fragmentation of climate finance farmers, collectors, traders, and processors and other sources; (4) broken links between financiers and agricultural SMEs. While this discussion paper pays farmers; and (5) lack of capacity and readiness at special attention to the first, financial services may the country level. also include: •• Lending, short-term for working capital loans and longer-term for investment capital loans; •• Equity capital; Traditional Constraints on Financing for •• Leasing; Agriculture •• Mobilization of Savings and Deposits; and Accessing sufficient and adequate financing for agri- •• Financial intermediation, such as mobile financial culture has been difficult in developing countries services, transfers, payments, and insurance. 6 Making Climate Finance Work in Agriculture Smallholder farmers find it hard to access finance. Agricultural SMEs also find it difficult to access They generally have little financial literacy, scant or no financing, especially the longer-term loans they need collateral, few alternative and supplemental sources of to invest in order to grow their businesses. SMEs income, and little or no credit history and track record are critical for agricultural development because of successfully repaying loans. Lenders, too, find it dif- their activities help to increase smallholder incomes, ficult to reach them because smallholders are often improve productivity, and add to the efficiency of highly disaggregated and scattered across remote areas value chains, thereby generating rural jobs. When far away from lending institutions. The resultant high SMEs lack the financing they need to grow to their transaction costs for the lender are rarely outweighed full potential, they generate fewer jobs. With rural by the small loan amounts that farmers require. Due unemployment already a major challenge in develop- to socioeconomic, political, and legal barriers (WB ing countries, the financing gap for agricultural SMEs 2014a), accessing finance is an even more acute prob- is thus exacerbating rural poverty across the globe. lem for women: in developing countries, only 50 While longer-term loans for investment are cru- percent of women have access to a bank account com- cial for SMEs to grow, they are much less accessible pared to 59 percent of men. Some of the barriers are than short-term working capital loans. SMEs require related to the difficulties women have in proving their loans too large to be met by microfinance but not identity, building financial history, and proving cred- large enough—and perceived as too risky—to be itworthiness, as well as their lack of land ownership met by commercial FIs. This longer-term finance and reduced physical access to financial services. gap, the “missing middle,” results from the mismatch Moreover, even where smallholder farmers have between the tenures of deposits and of medium- access to formal financial services, the lending meth- term loans, and from the fact that longer-term loans odologies and portfolio of financial products and often are much riskier for lenders. It is especially services on offer are often not designed to meet problematic when producers and enterprises wish to their financial needs and cash flows. For instance, invest in value-adding infrastructure that could sig- FIs tend to mostly offer short-term working capital nificantly raise their productivity and incomes but rather than longer-term investment, which limits are trapped in a lower-value equilibrium due to the the ability of smallholder farmers to invest in those lack of medium- and long-term finance. productive activities and equipment that can gen- Development agencies and both public and pri- erate more added value and increase productivity. vate sector actors have made multiple interventions Moreover, financiers often offer fixed repayment to overcome the agricultural financing gap. The schedules and short maturities that, because agricul- results have been mixed. The interventions have tural production cycles are seasonal, are not adapted often involved directed credits, mandated lending to smallholder cash flows. Moreover, the portfolio of by banks to agriculture, technical assistance for both financial products is often standardized rather than borrowers and lenders, and the provision of credit customized to the specific needs of the clients; thus lines and risk- sharing instruments, such as partial products and terms are often not demand-based, guarantees. However, financiers often lack incen- which sometimes leads to poor market uptake. tives to prioritize customer centricity and tend to Because the vast majority of farmers in developing use standard interventions that do not get past the countries are smallholders and women, the absence specific finance barriers in agriculture or meet the of suitable financial products remains a major obsta- needs of specific groups. For example, a short-term cle to the development of agriculture; the continuing loan with monthly repayments may be offered to a disenfranchisement of women and other smallholder farmer whose income is seasonal and who needs a farmers from the financial system also keeps them longer maturity and a repayment schedule aligned from opportunities for economic growth. The with seasonal cash flows. Initiative for Smallholder Finance estimates that total smallholder financing demand in Latin America, The Main Barriers to Lending to Agriculture Sub-Saharan Africa, and South and South East Asia2 is estimated at US$210 billion (Dalberg 2014). While the difficulties of closing the financing gap Moreover, the financing gap is likely to widen sub- for agriculture are numerous, this section dis- stantially with the heightened need for longer-term cusses three of the most common barriers: an inad- loans to fund adaptation and mitigation activities. equate enabling environment, exposure to specific Financing Climate-Smart Interventions in Agriculture 7 Figure 2.1.  Key Barriers to Lending assess, accurately estimate, and manage specific and multifaceted agricultural risks. For instance, one of the most common characteristics of the agricultural sector in developing countries is the inability of both Enabling Environment farmers and financiers to fully manage the impacts of the risks related to the seasonality of agricultural cash flows, which has severe effects on both the financial management capacity of farmers and the quantity Transaction Risks and quality of the products financiers offer them. Costs On the one hand, the revenues smallholder farm- ers and agricultural SMEs generate often depend on seasonal production cycles. The resulting variability in income and liquidity over the course of a year can agricultural risks, and high transaction costs. These make it difficult for them to manage their finances, three barriers (Figure 2.1), which most limit the abil- which in turn limits their capacity to invest in pro- ity of financiers to lend to farmers and SMEs, are ductive activities and save capital to invest in equip- closely related and thus affect each other. ment or access other financial services. On the other hand, irregular cash flows are also risky for finan- Inadequate Enabling Environment ciers, particularly if their investments are spread over long periods of time and are to be repaid in lump- A lack of effective policies and regulations governing sum installments over several seasons. This invest- agricultural finance not only discourages lending but ment structure can reduce the amount of deposits also creates additional barriers to the flow of liquid- available for lending, making loan management and ity to agriculture. How governments support devel- monitoring more difficult and costly and requiring opment of agriculture has a clear impact on how additional capital to design products tailored to the agricultural and financial markets operate. In some agricultural situation. cases, governments fail to recognize the economic Moreover, farmers and agricultural SMEs are and market potential of agriculture, inject subsidies often ill-equipped to manage the specific risks of the that distort the financial environment, discourage the agriculture sector. They often lack the knowledge development of private sector solutions, and create and capacity to recognize and manage those risks additional barriers to financing for agriculture. Quite and diversify their activities accordingly. In many common practices are mandatory lending quotas, cases, they either focus exclusively on one agricul- highly concessional lending de-linked from the mar- tural activity or have a portfolio of activities that is ket, loan rescheduling and forgiveness, interest rate only apparently diversified because all the activities subsidies and ceilings, highly subsidized insurance, are exposed to similar risks. They also often lack the limitations on product development (warehouse skills and necessary resources to improve their agri- receipts, leasing), savings mobilization, and contract cultural practices and technologies, buy higher-qual- enforcement. ity inputs, and (where available) acquire insurance to Moreover, a lack of effective policies and regulations help them better manage their exposure and reduce can also affect sectors that, while not related directly to its negative impact on their production, incomes, agricultural financing, are essential to its development, and thus repayment capacity. Among risks specific to such as infrastructure and telecommunications. A lack agriculture are (WB 2014b): of policy support for these sectors may perpetuate some of the challenges that agriculture faces, such as •• Production risk: the variability in agricultural high transaction costs and information gaps. output due to external and internal factors. The main external factors are climatic risks (drought, Lack of Capacity to Manage Specific Agricultural rainfall, changes in temperature, etc.) and the Risks risks of pests and diseases. Internal factors are those intrinsic risks derived from inadequate farm The complexities of agriculture require that both management practices, such as lack of adequate farmers and financiers simultaneously understand, farming skills and use of poor-quality inputs. 8 Making Climate Finance Work in Agriculture These risks are significantly higher for farmers Risk Profiles along the Agricultural Value Figure 2.2.   and SMEs that concentrate production in single Chain crops that are sensitive to specific inputs, climates, Perceived as low risk More access to finance and harvest timing. •• Marketing risk: the inability to sell on time, in the Retailers right quantities, or to an acceptable quality stan- dard. This is highly influenced by the absence of marketing contracts and the short-term and long- Traders term market situation, which severely increases exposure to this type of risk. Furthermore, the Perceived Less lack of sufficient finance and adequate inputs to as high access risk Producers/Farmers to finance produce the right quantity and quality exacer- bates the exposure. •• Price risk: the likelihood of financial losses due to changes in the level or volatility of commod- The risk profile of the borrower and the pur- ity prices. Often in agricultural markets there are pose of borrowing significantly influence how much significant information asymmetries and a lack of financing is available (Figure 2.2). Smallholders are good communications infrastructure. The prices usually less able to access finance than are SMEs; gen- that outputs will sell for in the market are unknown erally, the further up the agricultural value chain a for farmers at the time of planting, and these vary potential borrower is, the easier it is to access finance, according to the supply and demand at the time of because SMEs that are aggregated and integrated in sale. Often, too, farmers and SMEs lack facilities for value chains are better-placed to meet the lending storing non-perishable products to sell when prices criteria of financiers. are more favorable, and are unable to access future and forward contracts and hedging options. High Transaction Costs Financiers are also often ill-equipped to understand High transaction costs pose a substantial barrier to or manage the risks specific to agriculture. Because lending to farmers. Compared to borrowers located they often do not have the technical knowledge neces- in densely populated urban areas, farmers and agri- sary to understand the economics of farming and how cultural SMEs tend to be located far from FIs, which agricultural markets work, many lenders fail to under- often can be accessed only via poor roads and related take detailed diagnostics to identify the specific risks inadequate physical infrastructure, such as electric- associated with agriculture, which leads to their per- ity and communications. Moreover, the low popu- ception that this is a high-risk sector. Moreover, they lation densities of rural areas mean that reaching often are unfamiliar with the structured risk manage- those farmers that are disaggregated and thus not ment approaches and skills they need to accurately integrated into value chains is significantly more dif- calculate and manage those risks and to assess the ficult, and therefore more expensive. capacity of farmers to reduce them. Coupled with the To reach the market segment made up of small- often-insufficient risk management capacity of farm- holders and agricultural SMEs, many financiers ers, the result is that financiers lend only to those cli- would need to make substantial investments in ents they believe have a lower credit-risk profile. expanding branch networks, recruiting and train- As a way to manage risk, therefore, financiers ing new staff, and building systems to promote, often request collateral from smallholder farmers process, supervise, and collect on loans. These trans- and SMEs, who often have little or no collateral, action costs generally reduce the profit margins that either because they do not own land or other valu- financiers can make only by administering a large able assets, or because they live in areas where land number of relatively small loans, which discourages property rights are not recognized or land titles are them from lending to farmers. Reducing some of the not registered. Even when farmers have assets, they transaction costs may require new financial service are often of low monetary value or unsuitable to delivery channels that use information and commu- meet financing requirements, in which case, FIs may nication technologies (ICTs) and innovative partner- impose restrictive lending conditions. ships and business models so that they can expand Financing Climate-Smart Interventions in Agriculture 9 From Financing Agriculture to Box 2.1.   Box 2.2.  “Climate Finance” in this Paper Financing Climate-smart Investments in Agriculture In this discussion paper, climate finance refers to the flows of capital from both public and private sources Building climate-smart food production systems will that support and finance climate-smart investments require additional capital, particularly from public and aim to achieve climate change adaptation and sources, and customized financial products (FAO mitigation objectives. Climate finance is considered to 2012). In particular, climate-smart investments in agri- be a source of capital for climate-smart investments culture tend to require substantial upfront investments that has demonstrated its ability to unlock additional to support the transformational changes necessary to public and private capital from a variety of sources, heighten farmers’ productivity and their capacity to including domestic national budgets, the private sec- adapt to climate change while reducing the emission tor, bilateral and multilateral actors, DFIs, and institu- intensity of what they produce. This requires not only tional investors. a significant increase in the amount of capital avail- able but also longer maturities (5–7 years) and more flexible conditions (repayment schedules adjusted to cash flows) so that farmers can make the necessary Within the ecosystem of finance, sources that are cat- investments to maintain or increase current yields, egorized as “climate finance” can be critical to: produce more food on less land, and adopt climate- smart practices and technologies to increase their •• Unlocking additional sources of public and pri- resilience while also reducing emissions.. vate capital to finance or co-finance both pub- lic and private goods, not only through project development but also by establishing financial their networks and significantly lower the costs of aggregation models, among other options, to fur- transactions compared to those of the traditional ther climate-smart investments in agriculture. “bricks and mortar” approach. •• Strengthening the links between FIs and farmers Leveraging additional finance for climate-smart to effectively channel sufficient flows of capital to investments in agriculture requires consideration of both smallholder farmers and SMEs. how to address specific barriers. However, with the •• Supporting and paying for the necessary—and appropriate tools and financial instruments, financiers critical—technical assistance to increase the would be able to increase the proportion of climate capacity of the financial ecosystem, including finance flowing from public and private sources to financiers, smallholder farmers and SMEs, and agriculture and provide the support necessary for agri- other agriculture actors. culture to both mitigate and adapt to climate change. Scope of Climate Finance How Climate Finance Relates to While climate finance has evolved over the years, Agricultural Finance there is as yet no unique definition (but see Box All development finance today is provided in a world 2.2). In the broader sense, climate finance refers to shaped by climate change, which jeopardizes the all financial flows, regardless of origin, that help achievement of core development goals and most to achieve climate change adaptation and mitiga- impacts poor people and the underprivileged; finance tion objectives. The Climate Policy Initiative (CPI), of all types will be critical to support the transition the Organisation for Economic Co-operation and to low-carbon, resilient economies in all sectors. Development (OECD), the multilateral development Ultimately, the increased use of public climate finance banks (MDBs), and other institutions track parts of has the potential to unlock additional finance, par- these financial flows annually. Tracking annual finan- ticularly from private sources; it can also support cial flows that support climate objectives helps policy structuring the enabling environments needed to sup- makers, investors, and other actors to better under- port healthy public and private sectors and increase stand the total amount of actual investments and cli- the flow of agricultural finance directed to farmers mate finance committed globally and also provides to expand the domestic revenue base. All sources of a context for the estimates of additional investment financing are needed to make this transition a success. needed to meet mitigation and adaptation objectives. 10 Making Climate Finance Work in Agriculture This discussion paper explores the importance finance, among them grants, low-cost project debt of public and private sources of climate finance in (“concessional” loans), market-rate debt, project unlocking, catalyzing, and accelerating climate-smart equity, private equity funds and other aggrega- investments in agriculture. It therefore gives priority tion vehicles, balance sheet financing, and risk to the ability of climate finance, specifically public mitigation instruments, such as guarantees and climate finance, to unlock additional sources of capi- insurance. tal, especially private, throughout the entire climate finance ecosystem to accelerate climate-smart invest- Recipients ments that can help smallholder farmers and SMEs meet adaptation and mitigation objectives. Recipients of climate finance fall into several general The annual reporting by CPI on all climate categories: finance is one of the most comprehensive reporting mechanisms to date. Included in the CPI publication •• Public recipients; Landscape of Climate Finance are both funds origi- •• Private recipients; nating from public sources and the investments of •• Private NGOs and foundations; a wide range of private financial actors. While CPI •• Public-private recipients, primarily public-private does not claim to capture all financial flows support- partnerships (PPPs); and ing climate-smart investments, it does draw on data •• Unknown sources. from a variety of sources, including OECD/DAC, the MDBs, the International Development Finance Uses Club, and private finance for energy investments as captured by Bloomberg New Energy Finance. CPI Climate finance is usually directed to those uses that defines climate finance as “the financial resources achieve mitigation objectives and adaptation objec- paid to cover the costs of transitioning to a low- or tives and those that meet multiple climate objectives. zero-emissions global economy and to adapt to, or CPI tracks total investments in projects, not sim- build resilience against, current and future climate ply the incremental costs of making a project meet change impacts” (Falconer and Stadelmann 2014). mitigation or adaptation investment objectives. It does not track revenue support mechanisms, such as revenue from carbon credits or feed-in tariff mecha- Sources and Intermediaries nisms. This helps ensure that financing counted as This category is perhaps the most important for climate investments are actual investments, not understanding how and where financing that sup- hypothetical calculations about incremental invest- ports climate action originates, because it covers ments over carbon alternatives. sources of capital from the following: Traditionally, international climate agreements have a primary focus on public sources of finance •• Government budgets (public capital); that support climate-smart investments. In this •• Public financial intermediaries, such as bilat- context, climate finance consists of those funds pri- eral aid agencies, climate funds, and multilateral, marily provided by governments to meet climate bilateral, and national development finance insti- change mitigation and adaptation objectives that are tutions (DFIs);3 channeled through national, bilateral, regional, and •• Private financial intermediaries, such as commer- multilateral international entities, such as bilateral cial FIs, private equity, venture capital, infrastruc- aid agencies, and national, regional and multilateral ture funds, and institutional investors; and DFIs, among others. It also includes climate-spe- •• Households, private national and multinational cific funds, such as the Green Climate Fund (GCF), companies, and project developers (private Climate Investment Funds (CIFs), the Global capital). Environment Facility (GEF), and bilateral climate funds that finance mitigation and adaptation invest- ments, including the technical assistance and capac- Instruments ity building needed to facilitate and encourage the There are several financial instruments that ema- transition to a low-carbon, climate-resilient path for nate from intermediaries and sources of climate developing countries. Financing Climate-Smart Interventions in Agriculture 11 Overview of Climate Finance Architecture “blended finance.” Used in a targeted and disciplined manner, it is considered an effective way to deliver The relationship between the “climate finance archi- subsidies without crowding out other sources of tecture,” the channels of public sources of climate financing or unnecessarily distorting markets. While finance, and its ability to unlock private sources of such funds are considered concessional, the pricing capital is critical, because those public sources are of financing with respect to private sector operations best able to catalyze and crowd-in sources of pri- in particular is meant to minimize the subsidy ele- vate capital. Understanding the landscape of climate ment to just what is needed to make the investment finance in general, and the specific role of its pub- happen. lic sources, can provide critical insights into how to make finance more effective in achieving climate objectives along the entire agricultural value chain. Blended Finance Currently, the financial architecture behind pub- The term “blended finance” has emerged over the lic climate finance flows is multifaceted. Within it, last few years as donors and philanthropies have rec- it is important to put the spotlight on the impor- ognized the increasing need to attract private capital tant role of the dedicated climate finance funds that to address development objectives. Blended finance have been established as vehicles for donor funding specifically refers to the ability to use scarce public to finance mitigation and adaptation investments. resources structured through grants, low-cost debt, Among those that support climate-smart invest- guarantees, and (patient) equity both at the project ments in agriculture are: and vehicle level in emerging markets to crowd in pri- vate capital. Blended finance occurs in most sectors •• Green Climate Fund; important for achieving climate change objectives, •• Global Environment Facility (GEF); among them energy, infrastructure, and agriculture. •• Least Developed Countries Fund (LDCF – GEF); For example, the Global Agriculture and Food Security •• Special Climate Change Fund (SCCF – GEF); Program (GAFSP; Box 2.3) is a donor-funded mecha- •• Pilot Program for Climate Resilience nism created to scale up investments in agriculture by (PPCR – CIF); blending public sources of capital with MDB own- •• Adaptation Fund (AF); account financing and to crowd-in private investment. •• Bio-carbon Fund; and Blending public sources to crowd in private •• Amazon Fund. investment is particularly useful when: Public sources of climate finance (US$148 bil- •• The perceived risks in the market are higher than lion in 2014) make up a small portion of the total the actual risks, and enticing private investment more general financing (US$391 billion in 2014) to meet development objectives proves or demon- that works to forward climate objectives each year strates the business case for commercially viable (CPI 2015). These funds also have an important role activities; and in unlocking additional sources of private capital, •• Significant development impacts can be gained, including financing from project developers, com- but perhaps over a longer time horizon than mercial FIs, private equity, and (sometimes) institu- investors are typically used to; in these cases, tional investors. structuring public sources can help crowd-in the An important characteristic of these public necessary private investment. sources is that they can offer more attractive terms than the markets. Many bilateral and multilateral Blended finance has also been widely used in channels, and almost all specific climate funds, aggregation vehicles with local FIs and fund-of- deploy this financing into public and private invest- fund structures, and in the impact-investing space ments in the form of both grants and market-linked to crowd in private capital for projects that might financing instruments. The ability to price below the otherwise have been too small for direct invest- market gives these funds a particularly catalytic role ment. Public funding blended into these aggregation in financing projects by filling the gap that the mar- vehicles makes it possible for risks to be shared with kets cannot or will not finance due to risks, real or donors, allows for a portfolio approach to managing perceived. This approach has come to be known as risks, and can attract private investors. 12 Making Climate Finance Work in Agriculture Box 2.3.  The Global Agriculture and Food Security Program (GAFSP) GAFSP supports critical medium- and long-term interventions early-stage private-sector activities in agriculture that may not needed to ensure strong and stable policies and more invest- attract commercial funding due to perceived high risks. ment in agriculture, and to make transformative impact on rural incomes and food and nutrition security in the world’s poorest Through both windows, GAFSP aims to attract private invest- countries. Implicit in these goals is the program’s concerted efforta ment and provide innovative financing solutions across the entire to increase climate resilience and offset any negative effects on food supply chain in order to increase production and incomes or from climate change, to which the poorest countries are the for those living and working in the world’s lowest-income coun- most vulnerable. tries. Through experience, GAFSP has demonstrated how to GAFSP works through complementary public and private sec- leverage both public and private resources: for all Public Sector tor investments: Window projects now underway, 60 percent of financing is from GAFSP and 40 percent from other sources; for the Private Sec- • The Public Sector Window provides grant financing for stra- tor Window, the leveraging ratio of GAFSP resources and other tegic, country-owned, and country-led programs in low-income private funds is 1:7. Through its complementary windows, GAFSP countries that have prioritized agricultural development and has been able to demonstrate, on the ground, the development put in place a sound policy framework. impacts that can be achieved when public and private financing • The Private Sector Window provides a range of blended work together. finance solutions (loans, guarantees, and equity) to support a Twenty-three GAFSP Public Sector Window projects and 45 percent of funds, contribute to climate change co-benefits through various climate-smart activities. Role of Climate Finance in Agriculture and its financing, as well as the risks and effectiveness of potential mitigation measures, so that decision- Climate finance can play a critical role in directing making incorporates climate risk considerations to liquidity to agriculture. Agricultural investments that help address, where possible, how investments can address mitigation and adaptation goals are eligible be risk-proofed. To this effect, it is critical to ensure for public sources of climate finance. The sources are that a structured and systematic approach is used to mainly national, bilateral, and multilateral sources, undertake due diligence and flag potential climate DFIs, and dedicated climate funds, such as the GEF, risks, both short- and long-term, and help ensure the CIFs, specifically the Pilot Program for Climate that these are properly assessed and managed to Resilience (PPCR-CIF), and the new Green Climate help mainstream climate resilience into policies and Fund (GCF). These sources of public climate finance investments. In this regard, climate finance must play are essential to heighten climate-smart investments a catalytic role in providing the resources and build- in agriculture and support the transition to low-car- ing the necessary capacities to facilitate this process. bon and climate- resilient economies. When public climate finance is used effectively For instance, the World Bank Group has commit- through a balance of risk mitigation and other mar- ted to increase the climate share of its portfolio from ket-linked instruments that help rebalance the risk- 21 to 28 percent by 2020, when it should reach total reward profiles of highly impactful demonstration financing, including leveraged co-financing, of about investments, financial instruments can be used to $29 billion a year. In particular, the WB has com- leverage and catalyze private finance in agriculture. mitted to 100 percent of its agriculture operations Climate finance can be tailored to meet the risk pro- being climate-smart by 2019; to date 42 percent of files of all types of investors interested in realizing the Agriculture Global Practice pipeline projects are climate-smart investments, from those looking to already delivering climate-smart investments. increase direct access to finance for smallholders and However, in light of climate change, these SMEs to those interested in more complex value chain resources must be used efficiently because increasing finance, trade, and commodity financing and aggrega- the amount of public climate finance available may tion vehicles that offer more attractive structures for not be sufficient to build more climate-smart food large-scale impact and institutional investors. systems. It is essential to clearly understand the risks Climate finance can also be critical in reducing that climate change poses to the agriculture sector risk perceptions and crowding in private capital. Financing Climate-Smart Interventions in Agriculture 13 Potential functions of climate finance in investments •• Of total climate finance flows, 93 percent was allo- in agriculture are two-fold: cated for mitigation, 6 percent for adaptation, and 1 percent for combination activities. •• Climate finance can fill a financing gap and catalyze •• Of the $391 billion total, only $6–8 billion was investment that would not otherwise happen unless invested in agriculture, forestry, and other land there are risk mitigation/risk-sharing instruments use. About $3 billion was directed to adaptation or softer terms or subordinated positions that allow and another $3 billion to mitigation (CPI 2015). for investment of private capital; and •• It also offers an opportunity to prove its viabil- In addition to the most common barriers to lend- ity to private investors and commercial lend- ing to the agriculture sector—inadequate enabling ers who are unwilling to expand their lending in environments, exposure to risks, and high transac- agriculture. tion costs—a variety of other factors also constrains access to sufficient climate finance to enable scaling The second function is perhaps more critical to up climate-smart investments in agriculture in most scaling up liquidity at all levels of the agriculture developing countries: financing value chain and could help to dismantle some of the more entrenched barriers for financial •• Insufficient awareness of the vulnerability and markets and actors to expand into agriculture at the contribution of agriculture to climate change scale. has traditionally directed the attention of climate Climate finance has in the past been deployed to finance to other sectors. Further, the lack of econ- support agricultural projects through the following omies of scale, due to the small-scale composi- basic instruments: tion of the farming sector, has made it hard for agriculture to demonstrate its potential to achieve •• Grants; positive climate outcomes at scale. As a result, •• Loans, both concessional and not concessional most climate finance resources have been directed and in senior and subordinated positions; to sectors that can quantifiably demonstrate posi- •• Guarantees and other risk-sharing mechanisms; tive impact and significant reduction of GHG •• Equity, often more patient or willing to cap emissions in the short term. returns, at the project and the vehicle level; and •• The agriculture sector has limited capacity to •• Performance-based mechanisms identify its financial needs for adaptation and mitigation purposes. Moreover, lack of agree- The selection of specific climate finance instru- ment on the very definitions of adaptation and ments depends on several factors, including: mitigation in agriculture and insufficient tech- nical and financial capacity to screen for climate •• Which market barrier is being addressed; risks and build climate-smart agriculture profiles, •• Which segment of the market is being addressed; much less the necessary cost-benefit analysis and •• Who the counterparties in the investment are; investment plans, have limited the ability of gov- •• The limits of other sources of private capital in ernments and other stakeholders to quantify and that market; and mobilize the investments needed to make agricul- •• Total market liquidity. ture more climate-smart. •• Climate finance resources are fragmented (Salmes Barriers Preventing Climate Finance from et al. 2012). Traditionally, most of the climate finance available (93 percent in 2014) has been Flowing into Agriculture directed to mitigation purposes, specifically the It is estimated that only a small portion of total cli- energy sector, because it can reduce GHG emis- mate finance flows into agriculture. sions and demonstrate “quick wins” in the short term (CPI 2015). However, donors and funds like •• The total amount of climate finance invested the Green Climate Fund are increasingly recogniz- globally in 2014 was an estimated US$391 billion, ing both the vulnerability to and the contribution from both public (38 percent) and private (62 of agriculture to climate change and acknowl- percent) sources. edging the importance of allocating resources 14 Making Climate Finance Work in Agriculture to climate change adaptation in agriculture by •• The evidence base for the most suitable climate- explicitly incorporating it into their mandates smart interventions is insufficient (FAO 2013). (GCF 2015). Nonetheless, far more resources Because climate-smart investments in agriculture are needed to appropriately fund climate-smart are context-specific, adaptation and mitigation interventions, which require a holistic approach interventions need to be tailored to the particular that promotes productivity, adapting to climate local context. However, more research is needed change, and reducing emissions. to clearly identify the climate-smart interventions •• The links between financiers and smallholder that would be most suitable for specific contexts farmers and SMEs often do not work effectively and their adaptation and mitigation potential. and at scale. Current channels to deliver finance to Research is also needed to produce technological the agriculture sector often do not directly reach innovations that can accelerate the scaling-up of farmers, who are ultimately responsible for doing climate-smart investments in agriculture (FAO what needs to be done to adapt and mitigate the 2014). effects of climate change. This is increasingly chal- •• Currently, metrics and tools are not adequate to lenging when climate-smart interventions require accurately measure the impact of climate-smart upfront investments or additional capital. Hence, interventions. Agriculture has traditionally faced it is critical to improve the current climate- significant constraints on assessing the potential financing architecture and to open more efficient, impact of adaptation and mitigation activities innovative, and transparent channels to facilitate due to the lack of internationally recognized met- the flow of finance directly to farmers, so they can rics and monitoring and evaluation tools that can access the necessary resources to invest in climate- measure the exact impact of such interventions. smart interventions and thus increase their capac- Therefore, more research is needed to identify ity for resilience and mitigation. accurate ways to measure climate outcomes at the •• Countries often do not have the capacity to access farmer and firm level. Metrics that are not ade- all the climate finance they need. Another prob- quate and overly complex impact measurement lem for investors is often the lack of a robust and methodologies and tools also discourage private attractive pipeline of climate-smart investments in investments in agriculture. agriculture. Quite often this is closely related to the lack of capacity in recipient countries to conduct Notes environmental and socioeconomic studies, address 1. A significant amount of finance flows to agriculture climate change constraints, and design techni- in the form of public subsidies (direct grants from the gov- cal projects that deliver climate- smart outcomes ernment), but this issue is not addressed in this discussion while meeting all the requirements for accessing paper. climate finance. More technical and financial sup- 2. This figure excludes China, Central Asia, and the Middle East and North Africa. port is needed to build the capacity and readiness 3. CPI considers government sources of capital and of countries to address climate-change constraints public FIs to be two distinct sources of capital, although and build a robust and sustainable pipeline of many governments channel their capital through pub- projects that can attract further investment. lic FIs. Chapter 3 LEVERAGING CLIMATE FINANCE TO MAKE AGRICULTURE PART OF THE SOLUTION As is already clear, the substantial financing gap in Key Messages: the agriculture sector can only widen given the addi- tional capital needed to help developing countries • Climate finance can address the financing gap in tackle the challenges that climate change poses to the the agriculture sector by channeling additional agricultural sector. It is therefore essential to increase sources of finance that deliver positive climate the flow of finance to farmers so they can better outcomes directly to smallholder farmers and adapt to climate change and reduce the emissions SMEs. • It can also function as a catalyst for the design intensity of agricultural production. Climate finance and adoption of innovative mechanisms to lever- is critical to addressing this financing gap by provid- age additional sources of capital, specifically from ing new and better-targeted sources of finance and private sources. directing them (either directly or through intermedi- • Such mechanisms might include (1) PPPs to lever- aries or aggregation structures and vehicles) to those age not only resources but also expertise and smallholder farmers and SMEs that can achieve posi- capacities; (2) investment vehicles that can help tive climate outcomes. attract additional capital by diversifying, manag- If climate finance is to effectively address this ing, and rebalancing risk-return profiles; and (3) bundling a wide range of financial instruments to financing gap, barriers to lending for agriculture will make the use of capital more effective. have to be dismantled. The current links between FIs • Entry points that can help direct public climate and smallholder farmers and SMEs do not always finance into agriculture and link financial institutions work properly, in particular at scale, and financial to smallholder farmers and SMEs are (1) improving resources are not reaching those farmers and SMEs the enabling environment; (2) supporting FIs to build that will need to adapt and mitigate the adverse up their risk management mechanisms; and (3) sup- effects of climate change. It is therefore essential to porting FIs to reduce transaction costs. first create the conditions that will allow climate • For each entry point, there are a number of inter- ventions that could be undertaken to achieve the finance to flow to farmers and SMEs directly. objectives of that specific entry point. For each To this end, climate finance could be used to potential intervention, there is a list of suggested reinforce the links between FIs on the one hand and initiatives that could be funded with climate smallholder farmers and SME agribusinesses on the finance. other. For instance, climate finance resources might • If the suggested interventions and mechanisms be used to develop or improve the agricultural finance are to function effectively, it is imperative that enabling environment, such as policies and regula- climate finance provides technical assistance to both financiers and smallholder farmers and tions necessary to mobilize and channel financial SMEs so that both parties can build the capaci- flows to farmers. They could also be used to support ties they need to use the resources available FIs to better manage risks and incentivize them to effectively. increase lending to farmers and SMEs, to develop new financial delivery channels, and to design financial 16 Making Climate Finance Work in Agriculture instruments and structures tailored to suit the needs sources. PPPs in particular tend to have a multiplier of smallholder farmers and SME agribusinesses. effect by leveraging diverse types of expertise, skills, This would be a win-win for climate finance, because resources (technical and financial), and networks such resources could help bring about positive climate (Figure 3.1). More importantly, they can help to outcomes while also generating significant financial accommodate the interests of a wide range of actors and social returns. To achieve this, public and private with different risk appetites, desired investment sources of climate finance will need to adopt innovative returns, and social, economic, and environmental ways to attract additional capital to the agricultural sec- goals. Partners in PPPs may be: tor. Specifically, these sources will need to: •• Public donors; •• Use partnerships and innovative investment vehi- •• International and nongovernmental organiza- cles to bring in additional finance for climate-smart tions (NGOs); interventions in agriculture, such as using conces- •• Foundations; sional public resources to reduce risk and help •• Research institutions; rebalance the risk-reward profiles of investments; •• UN organizations; •• Identify the best entry points for directing cli- •• Development FIs; mate finance into agriculture and for linking FIs •• IFIs; directly to smallholders and agricultural SMEs; •• Private companies; and and •• Impact or institutional investors. •• Build the necessary capacity to maximize these sources of climate finance. Innovative Investment Vehicles Well-designed layered capital structures are often Innovative Ways to Attract Additional essential for leveraging additional capital while Capital to Agriculture meeting the different expectations of each poten- tial investor. Such structures not only increase the Public-Private Partnerships amount of capital available but also diversify risk Partnerships, particularly PPPs, can help catalyze and investment returns, and add flexibility to the additional capital from both public and private terms (maturity) and uses of the capital. PPPs that Figure 3.1.  Multiplier Effect of PPPs Donors Private Investors Donors Public Investors Public Investors International International Financial Financial Institutions Institutions Indi vidu al F inan cing Private Investors Pub lic-P riva te P artn ersh ips Leveraging Climate Finance to Make Agriculture Part of the Solution 17 Figure 3.2.  Examples of Layered Capital Structures •• Grants; •• Senior debt, both concessional and nonconcessional; Private Notes Senior Notes preferably with medium and long-term tenures; Investors •• Mezzanine debt instruments, often with conver- DFIs, IFIs Senior Shares Subordinated Subordinated sion, subordination, deferral, and other features, Loans Notes usually on concessional terms; DFIs, IFIs Mezzanine Shares Senior Shares •• Guarantees and risk-sharing mechanisms, usually on concessional terms; Public •• Local bond issues to enhance the availability of Donors Junior Shares Junior Shares Source of Structure No. 1 Structure No. 2 local-currency financing; Capital •• Equity, often more patient or willing to cap returns; and •• Performance-based mechanisms, such as pay- have financial structuring skills and understand what ments or reductions in interest rates or principal potential investors are looking for can make a mean- amounts if agreed milestones are met. ingful contribution to the design and application of layered capital structures. Figure 3.2 is one example The bundling of several instruments at a time of this type of structure. may prove critical to providing more comprehensive In the type of capital structures shown in Figure solutions to financiers and private actors while also 3.2, junior shares would be the first to bear any capi- increasing the efficacy and efficiency of the resources tal loss; the higher up in the structure, the more risk allocated to each intervention. Caution should be protection capital has. The fund can be designed so taken, however, in both structuring innovative finan- that returns generated are guaranteed to be first paid cial vehicles and bundling multiple financial instru- to note holders, independent of the profitability of ments so as not to unduly complicate the structure to the fund. Other investors receive their share in the the point that transaction costs become prohibitive or net income according to their ranking. In this way, the success of the financial package is compromised. layered capital structures can use public funds to attract private capital to finance potentially profit- How Do PPPS, Investment Vehicles, and Bundled able and sustainable investments while incentiviz- Financial Instruments Work Together? ing additional investments and investors, managing expected returns, and diversifying the risk to inves- PPPs and investment vehicles alone will not suffice tors. Funds from foundations could also be attracted to both expand the amount of liquidity and expertise into such aggregation structures. and make sure they are channeled all the way down In addition to well-designed structures, success to smallholder farmers and SMEs. It will be necessary depends heavily on finding fund managers who under- to design more innovative finance models in which, stand the sector well and can identify potentially prof- for instance, PPPs use these investment vehicles (lay- itable and sustainable deals. Also essential is proper ered capital structure) to then channel finance flows alignment of interest and incentives to ensure that pub- to FIs that in turn on-lend to smallholder farmers, lic funds are not used to subsidize unprofitable deals or SMEs, and investment projects. An example of this deals that would not meet the targeted outcomes. finance model is the one used by Finance in Motion (Figure 3.3; see also Box 3.2). Bundling Financial Instruments Where they are able to catalyze additional capi- tal, sources of finance will need to identify the best An effective way to utilize climate finance is to bun- entry points to direct climate finance into agriculture dle one or more financial instruments with techni- effectively and to link FIs directly to smallholders cal assistance (Box 3.1). Bundled packages have the and agricultural SMEs. To overcome the barriers the potential to offer more comprehensive solutions to agricultural sector faces to access finance, sources of FIs and other parties to help improve and expand finance will have to consider a diverse range of initia- agriculture lending and other forms of financing. tives. To this end, climate finance can be highly effec- Some publicly funded financial instruments that tive in facilitating and accelerating initiatives and could be packaged with technical assistance are: increasing their effectiveness. 18 Making Climate Finance Work in Agriculture Box 3.1.  Peru Case Study: Global Canopy Program – Unlocking Forest Finance The region of San Martin in northern Peru is at the frontier of Since agricultural lending in rural Peru entails a variety of Amazon deforestation. Supply chains for coffee, cocoa, and rice risks, international investors might demand a high return. This provide livelihoods to smallholders, but it is often cheaper to could create a floor on the interest rates offered to smallholders. expand into the forest frontier than try to make cultivated land To manage borrowing costs, the bond issue first will seek to lever- more productive. age the favorable credit rating of a national development bank. Unlocking Forest Finance (UFF) is a project of the U.K. Global The underlying loan pool will then be securitized (cash flows will Canopy Programme in collaboration with local partner Centro be earmarked for bond coupons and capital repayments), which de Desarrollo e Investigación de la Selva Alta (CEDISA). It will should provide comfort to investors in lieu of higher interest rates. provide smallholders with access to low-cost, long-term finance, Finally, major climate funds like the Global Environment Facility along with training in sustainable farming practices. Investment could provide first loss or junior equity, a repayment guarantee, in the supply chains will cost over US$300 million. A bond issue or both. in international markets will access billions in global debt capital While green bonds—which finance environmental activi- and provide necessary funding to local financial institutions (FIs), ties—are increasingly popular in the developing world, they must which will use the funding to invest in targeted supply chains. meet strict standards to qualify as “green.” Institutions issuing UFF will be more attractive to local FIs if they can use the lower green bonds require both financial and technical assistance to interest rates available on international markets to refinance their achieve this. UFF’s partner, the Climate Bonds Initiative, will pro- existing portfolios of environmental loans. Initially, these loans vide advice on achieving green certification for UFF’s San Martin will be warehoused in a special purpose vehicle (SPV) managed bond. The actual costs of certification could be met by grants from by a national bank. The SPV will then issue a bond; proceeds will donors. refinance the warehoused loans and provide capital for new loans within the UFF project. Figure 3.3.  Sample Finance Model for Finance in Motion Investors Donors Public Investors International Financial Private Institutional Institutions Investors Technical Assistance Development Finance Fund Facility Financial Technical Institutions Assistance, Investment Projects Small and Medium Training, Enterprises (SMEs) Research Final Beneficiaries Climate Finance Entry Points into have considerable potential to ensure that lending to Agriculture agriculture contributes to climate-smart outcomes. These initiatives focus on creating the conditions This section presents a number of initiatives that, necessary to develop an ecosystem that allows all who properly designed and applied, can increase financ- are directly or indirectly involved in the provision of ing flows to agriculture, specifically to smallholders agricultural finance to improve the links between FIs and agricultural SMEs. Moreover, these initiatives on the one hand and smallholder farmers and SMEs Leveraging Climate Finance to Make Agriculture Part of the Solution 19 Box 3.2.  The eco.business Fund Case Study Launched in 2014, the eco.business Fund is an impact fund In one case, the eco.business Fund made a US$10 million that invests to support biodiversity conservation and sustain- senior loan to Costa Rican Scotiabank to provide financing for able resource use while also generating financial returns. It is environmentally certified businesses in Costa Rica, such as Global structured as a public-private partnership, with different capital GAP and the Marine Stewardship Council. Scotiabank already has tranches offering a diversified risk-return profile for different cat- an established portfolio of agricultural and fishery clients and is egories of investors. Public investors, development finance insti- using the loan funds both to strengthen relationships with exist- tutions, and donors provide first-loss capital, taking on more risk ing partners and to identify additional candidates that align with in order to protect private investors that own senior notes. the aims of the Fund. The loan to Scotiabank is combined with The Fund channels its financing to businesses that hold a cer- technical assistance for bank staff to increase their understanding tificate for sustainable production, (e.g., from the Rainforest Alli- of certification processes and biodiversity conservation. ance) or those that have a measurable positive impact on biodi- The success of the eco.business Fund lending model shows versity. The average investment is US$5–10 million, and most are that capital tranches with diversified risk-return profiles can be for up to 10 years. Most financing is provided to local FIs, which used to attract private investors, and that partnering with local then loan to suitable businesses; up to 15 percent of capital is FIs makes it easier to direct funds to suitable businesses. The eco. directly invested in high-impact businesses or projects. Funding business model also demonstrates that offering technical assis- is complemented by a dedicated development facility that offers tance along with financing can significantly enhance the positive technical assistance to financial institutions and their clients. impact of investments. on the other. Such initiatives may include the use of lower the barriers to agricultural lending by banks climate finance to improve the enabling environment, and other financiers. The most important step for such as the policies and regulations necessary to mobi- governments to create environments that facilitate lize and channel financial flows to farmers and agri- the flow of finance to agriculture is to adopt a “do no cultural SMEs; new mechanisms and instruments to harm” principle that limits unnecessary interference better measure, assess, and manage risk; and cost-effec- in agricultural finance. To take this step, governments tive delivery channels that can reduce transaction costs. should identify and strive to replicate best practices In certain cases, combining several of the inter- and lessons learned about policies and regulations ventions and financial instruments proposed below that reduce barriers to agricultural finance and extend might prove more effective than a single intervention its reach and depth. These may include: or financial instrument alone. This chapter proposes a range of financial instruments (grants, conces- •• Climate-smart agricultural principles:2 Public pol- sional financing1, etc.) that could be used to support icy makers and governments can do a great deal each of the interventions suggested, but this is not a to catalyze additional climate-smart investments prescriptive list and any other financial instrument in agriculture by mainstreaming climate-smart could be used depending on the context and the agriculture principles into national policies and characteristics of an initiative. ensuring that they are widely adopted by all stake- It is critically important, however, to provide holders including, among others, government technical assistance to help lenders understand and ministries, financial service providers, SMEs, and build the capacities necessary to ensure appropri- farmers. ate design, bundling, implementation, and effective •• Enabling agriculture finance policies: Policy makers utilization of instruments and interventions, so that and governments could, where necessary, encour- greater—and more efficient—lending can be chan- age policy reforms that remove obstacles and neled directly to smallholder farmers and SMEs. promote the growth of agriculture finance and private investments and recognize agriculture as Improving the Enabling Environment a vibrant and dynamic economic sector with great potential to accelerate economic growth. Such Public Policy and Regulations reforms could in turn encourage market entrants The more effective and supportive the public policy to fill in finance gaps and create a more diverse and regulations—the enabling environment— the and dynamic agriculture sector. 20 Making Climate Finance Work in Agriculture •• Systems of property rights: Establishing or further immensely useful in helping financiers to enforce strengthening registries, such as cadaster systems, contracts. for land ownership can improve financiers’ risk •• Strong customer protection laws: Introducing or management by allowing farmers to have their reinforcing customer protection laws is essen- assets (collateral) recognized. That can increase tial to ensure that borrowers are treated fairly both the access of farmers to financial services and respectfully and avoid practices that might and longer-term loans and their willingness to harm them. Important components of such laws implement climate-smart practices. are transparency and information disclosure in •• Collateral registry for movable assets : Legal and contracts, pricing and interest rates, avoidance institutional frameworks and the necessary of over-indebtedness, and privacy of client data. registries to allow and encourage the use of •• Climate-smart advisory services: Policies and regu- crops, inventory, or equipment as collateral can lations that facilitate the collection and provision remove a significant barrier to farmers access- of timely and accurate climate-smart agricul- ing capital. tural and weather information services (through •• Mobilization of deposits: Many financiers cannot ICTs) can allow smallholders and SMEs to make mobilize borrower deposits because the regula- informed decisions and better manage their expo- tions are overly strict or entirely absent. To address sure to agriculture-specific risks. this issue, policy makers can introduce or improve regulations that enable institutions to mobilize Potential Role of Climate Finance deposits, which constitute one of the main fund- Climate finance could be used to support national ing costs for financiers in developing countries. and local governments by providing grants for capac- Large pools of savings could also be mobilized ity building and financial support to build the envi- by tapping into, among others, savings and credit ronment necessary to enable the flow of capital from cooperatives, savings clubs, and village and sav- climate finance sources to farmers. Among actions ings loan associations. Deposits could then help that could be undertaken to facilitate this: to provide the necessary liquidity for financiers to lend to farmers and especially lend longer-term to •• Establish public policies and regulations in the areas SMEs for investment purposes. of agriculture finance, property rights systems, col- •• Rural credit ratings agencies and bureaus with lateral registries for movable assets, mobilization of climate-smart components: Credit agencies and deposits, contract enforcement, customer protec- bureaus could allow FIs to benefit from credit tion, agent banking, and e-money, etc. ratings that help them evaluate the past and cur- •• Draft financial, social, and environmental guide- rent behaviors of current and prospective cli- lines3 (including metrics and monitoring and ents, both smallholder farmers and SMEs, which evaluation tools) to mainstream climate-smart would ultimately help them to determine the principles into national government policies and creditworthiness of their clients. Establishing programs. or strengthening credit ratings agencies and •• Establish or improve existing mechanisms to bureaus can enable financiers to provide a more accurately estimate adaptation and mitigation customized range of services. Moreover, inte- financial needs for achieving the climate-smart grating climate-smart practices and risk mitiga- agricultural objectives established in their INDCs, tion approaches into credit ratings would help and set up a route map and an action plan. create momentum within the markets for adopt- •• Develop effective screening tools that can be eas- ing these practices. ily used to assess beforehand the potential climate •• Reliable contract enforcement: Effective court sys- risk of a given investment or intervention. tems enable banks to enforce debts and recover •• Put in place monitoring and evaluation systems collateral, increasing their risk management and tools to track budgeted government invest- capacity and severely reducing loan defaults. ments in climate-smart interventions. Ensuring that court systems have the capacity and •• Set up meteorological stations to collect the nec- authority to enforce contracts can thus encour- essary data and disseminate (through government age lending to farmers. Similarly, mechanisms agencies, ICTs, etc.) timely climate and weather- that allow out-of-court settlements could also be related information. Leveraging Climate Finance to Make Agriculture Part of the Solution 21 •• Conduct research to improve the quality of agri- sustainable initiatives. Another way to address the cultural extension services and build the evidence information asymmetry is to establish PPPs that base needed to incorporate climate change con- function as climate- smart incubators. These PPPs siderations, especially adaptation and mitigation could serve as aggregators of farmers and SMEs and activities, into those services. provide brokering services nationally by identifying •• Organize international visits for those stake- smaller climate-smart projects and clustering them holders interested in accelerating climate-smart into CSA portfolios to which FIs can then link. agricultural investments to showcase success- More specifically, different models that include both ful examples elsewhere, so that they can be concepts could be developed to provide the follow- replicated. ing services: Model 1 (Figure 3.4.): Facilitating and Accelerating Financial Investment •• Climate-smart Investment Facilitators: Charging A mismatch in information between those requir- a fee for the service of matching investors with ing financing and those willing to invest can stem those FIs that have a portfolio of investments of the flow of finance between them. On the one hand, appropriate size that are categorized as climate- SMEs, financiers, and governments often lack access smart; and to adequate and sufficient capital to finance inter- •• Climate-smart Incubators: Charging a fee for the ventions that can develop agriculture at scale while service of matching FIs with both certified CSA achieving positive climate outcomes. On the other portfolios and CSA projects (i.e. directly with hand, while there are impact investors and potential smallholder farmers and SMEs, through facilitat- institutional investors who are interested in investing ing and development agencies, etc.) large sums of capital in climate-smart portfolios, they are often unaware of initiatives that can absorb such Model 2 (Figure 3.5): investments. •• Climate-smart Investment Facilitators: Becoming The risk-reward mismatch and, more impor- an intermediary that matches investors with tant, the information asymmetry can be addressed investments of appropriate size that are catego- by establishing PPPs that function as climate- rized as climate-smart4 and also design adequate smart investment facilitators. These PPPs can play layered capital structures to subsequently manage an essential role in mapping out existing national, and invest the assets accordingly. This model has regional, and international climate-smart initia- the advantage of significantly reducing transac- tives that require large sums of capital and clus- tion costs and risk for investors as well as carefully tering them into portfolios for investors seeking selecting those interventions that will achieve to invest in social, economic, and environmentally positive climate outcomes. Figure 3.4.  Example of a Climate-smart Investment Facilitator and Climate-smart Incubator Climate Smart Climate Smart Investment Incubators Facilitators art t e Sm t (i.e. Asset Managers, C art (i.e. Brokering Cli a en Fund Managers, etc.) I lim Sm Services based m Clim vestm lio nv ate a t e lio Pro ate S In ortfo es S tm m Clim Portfo on fees) jec ma P en art $ $ ts rt ts $$$ Financial $ Smallholder Investors Institutions Farmers & SMEs $$$ $ Model 1 22 Making Climate Finance Work in Agriculture Figure 3.5.  Example of a Climate-smart Investment Facilitator and Climate-smart Incubator Lower Risk Lower Risk Lower Transaction Costs Lower Transaction Costs Climate Smart Climate Climate Climate Investment Smart Smart Smart Portfolio Climate Smart Investments Portfolio Projects Investment Climate Smart Investors $$S$ $$$ Financial $$ Incubators $ Smallholder Facilitators Institutions Farmers & SMEs $$$$ $$$ $$ $ Model 2 •• Climate-smart Incubators: Acting as an interme- Potential Role of Climate Finance diary that offers FIs a portfolio of CSA projects, Climate finance could be used to support stake- raises capital with the appropriate risk and impact holders by providing grants or concessional finance appetite, and manages and invests the capital to enable the flow of capital from climate finance accordingly. This model has the advantage of sig- sources to farmers. Three different types of support nificantly reducing transaction costs and risk for are possible, for different purposes. FIs as well as careful selection of projects that have the potential to achieve significant positive cli- Grants: mate outcomes. •• Draw up clear guidelines for climate-smart screening. The guidelines should include precise The two models could be interchanged or devel- metrics, indicators, and monitoring and evalua- oped in other innovative ways to ensure that there is a tion tools5 that can identify, assess, and measure simple but constant flow of communication between the potential financial return, level of risk, and financiers (climate funds, institutional and impact social, economic, and environmental impact of investors, FIs, etc.) and recipients (FIs, smallholder an investment. The guidelines6 could then be farmers, SMEs, etc.) that are interested in making adapted to the specific context to determine the climate-smart investments in agriculture. worthiness of an investment. Equally important to facilitate and accelerate •• Support recipient countries as they build the financial investments is the critical role of technical necessary technical and financial capacity to assistance for both financiers and farmers. On the strengthen their readiness and their ability to one hand, technical assistance to farmers can help to access climate finance to address climate- change- broaden their capacity to understand, finance, and related constraints. adopt climate-smart interventions, which will even- •• Develop processes for classifying agriculture proj- tually increase their capacities to adapt to climate- ects and portfolios that achieve positive climate induced risks. That may significantly lower the risks of outcomes based on a set of accurate metrics as production over time compared to business-as-usual climate-smart. practices and thus improve the credit-risk profile and •• Build the capacity of foundations, INGOs, and creditworthiness of a given farmer, which may ulti- NGOs that advocate for enhancement of condu- mately lead to increased access to finance for climate- cive conditions for profit-making investments in smart interventions. On the other hand, financiers agriculture and climate-related areas. can benefit from building their capacity to under- •• Improve the capacity of farmers to understand stand how famers’ adoption of certain climate-smart the adverse effects of climate change on their practices and technologies can significantly minimize production systems, how more resilient adaptive some of the actual and perceived risks inherent in capacities can help them to better mitigate and agricultural lending and therefore increase the flows manage agriculture risks, and their potential for of finance to climate-smart investments. facilitating access to financing. Leveraging Climate Finance to Make Agriculture Part of the Solution 23 •• Improve the capacity of financiers to understand must establish or reinforce holistic risk management the potential of farmers’ adoption of climate-smart frameworks. The risk management strategies and practices for significantly reducing the actual and instruments that are appropriate are very context- perceived risks of lending to the agriculture sector. specific; because there is no one-size-fits-all solution, they may vary according to the client, the market, and Concessional financing: trade conditions. This context-specificity requires •• Support countries that have improved their financiers to assess and measure risks thoroughly enabling environments and have viable and and continuously in order to estimate accurately the innovative projects to attract private capital into likelihood of occurrence, exposure, and magnitude climate-smart investments, for example, credit of effect. lines or guarantees to financial intermediaries. To establish effective risk management frame- •• Establish entities (possibly PPPs) that can certify works, financiers need to build both their skills and or classify projects and portfolios as climate-smart; their capacity to understand their clients and the conduct economic, social, and environmental markets and the risks to which they are exposed. This audits; and resolve any issues that may arise. understanding will allow them to customize context- •• Set up entities (possibly PPPs) that can act as CSA specific solutions and help them to manage risks bet- investment facilitators, identifying climate- smart ter, reduce costs, expand their agricultural finance portfolios at scale and linking them to investors portfolio, and still increase their margins. (both impact investors and institutional investors The more comprehensive and customized the risk that observe specific economic, social, and envi- management approaches that are used simultane- ronmental criteria). These would greatly benefit ously by financiers, the more likely it is that managing from recruiting experienced general fund manag- risk in general and agriculture-specific risks in par- ers that have already worked in or are willing to ticular will be effective. The following mechanisms, if move into the sector. designed and applied appropriately, have significant •• Set up entities (possibly PPPs) that act as CSA potential to help financiers manage risks better and incubators, identifying climate-smart projects increase liquidity, in the form of both short-term and linking them to FIs. working capital and longer-term investment capital, •• Encourage asset and fund management firms to for smallholder farmers and agricultural SMEs. catalyze additional public and private investments that can be channeled to those private actors Rural Credit Rating Agencies and Bureaus (financiers, SMEs, etc.) that are realizing climate- smart investments in agriculture. One of the key challenges that financiers face in lend- •• Provide capital to FIs to lower their cost of funds so ing to smallholders and SMEs is that the information they can provide longer-term credit lines to farm- available to creditors and to borrowers is asymmetric. ers achieving positive climate-related outcomes. Well-functioning rural credit bureaus allow financiers to access up-to-date information on the past and pres- A combination of grants and concessional financing: ent credit behaviors of current and prospective clients •• Crowd in additional capital from both the public so that they can better evaluate the creditworthiness of and private sectors to support the development of potential debtors, monitor their credit circumstances, the necessary agriculture financial infrastructure and make informed decisions on credit and loan (credit bureaus, land registries, collateral registry agreements. Timely access to such data can eliminate for movable assets, etc.). the information asymmetries and enable financiers •• Set up innovation windows where companies to significantly improve their credit risk assessments and government can present ideas that dramati- and their portfolio management generally. This can cally improve access to finance for climate-smart lead to more lending to agriculture and more efficient investments in agriculture. and lower-cost credit markets (WB 2011). Moreover, it can have a very positive effect on the entire financial Risk Management Mechanisms ecosystem by enhancing overall financial supervision and financial sector stability. To recognize, measure, and manage effectively the The availability of rural credit rating agencies risks involved in agricultural lending, financiers also has a positive impact on borrowers because 24 Making Climate Finance Work in Agriculture Box 3.3.  Ecuador Case Study: Credit Bureaus for the Rural Poor In the late 1990s, Ecuador suffered a profound banking crisis were 10 micro-lenders, nongovernmental organizations and coop- that caused a huge drop in GDP, pushed up unemployment, and eratives, from the two poorest Ecuadorian provinces. The bureau increased poverty across the country. Credit Report was selected as partner, facilitated by RFR. RFR also In response, in 2003 the government introduced enabling regu- provided training on how to diagnose micro-lender processes, lations issued by the Superintendencia de Bancos y Seguros (SBS) data, and technological systems. that permitted the establishment of private credit bureaus and The results of project SERVIR were very positive, enabling it the sharing of data formerly protected as borrower rights. These to expand to more Microfinance Institutions (MFIs) across Ecua- replaced the public credit registry, which had collected informa- dor. Between 2004 and 2006, MFI portfolio volumes grew by 53 tion only from regulated lenders, leaving out the largely unregu- percent, the number of clients by 33 percent, and the average loan lated micro-lenders. Six credit bureaus were licensed, all receiv- amount from $1,800 to $2,400. Over this period, credit default ing client data from SBS. rates (1 day) fell from 41 to 10 percent. To foster the inclusion of the most vulnerable populations, A key factor in Credit Report’s success was the unique access who mainly lived in rural areas, and to share payment histories to data on borrowers that it had at the base of the pyramid between micro-lenders and credit bureaus, in 2005 Red Financiera through RFR’s members. This gave Credit Report better market Rural (RFR) launched the SERVIR pilot project. At that time micro- coverage than its competitors. Since 2011, Credit Report has lenders, which served more than 1.7 million largely rural clients, been the only one remaining of the six initial credit bureaus in were not mandated to share their information. Joining the pilot Ecuador. financiers can quickly and effectively conduct •• Build the capacity of credit bureaus to provide credit assessments of those clients with a good added-value services, such as anti-fraud tools, credit history. This translates into enhanced access portfolio monitoring, debt collection, and assess- to lower-cost capital that can be invested in pro- ment of the climate-smartness of a borrower’s ductive activities. Moreover, it can facilitate farm- performance. ers’ access to longer-term finance, since a solid •• Develop the tools necessary to incorporate cli- credit record is likely to significantly reduce their mate-smart principles into credit scoring, so risk profile (Box 3.3). that financiers can assess how creditworthy indi- viduals are and how increased productivity and Potential Role of Climate Finance resilience can impact their ability to successfully Climate finance could be used to provide grants, borrow and invest capital. concessional finance, or both to create the conditions •• Roll out trainings to build FI capacity to under- necessary to set up effective rural credit bureaus. Two stand and become active members of rural credit different types of support could be provided. bureaus. Grants: It is important to note that the proposed inter- •• Establish minimum standards and advocate with ventions could only be supported by concessional authorities to adopt the General Principles for finance if they have serious potential to become credit reporting systems (WB 2011). financially sustainable businesses. •• Build the capacity of rural credit bureaus to col- lect, validate, and disseminate data. Guarantees •• Draft and put in place guidelines (with metrics and monitoring and evaluation tools) that incor- By using triangular structures to transfer a portion porate climate-smart principles into credit records of the risk from the originator of the loan to a third so that investments can be tracked nationally. party who is not the borrower, these risk-sharing arrangements are generally used to expand financ- Concessional financing: ing in agriculture. On the premise of lowering or •• Crowd in additional capital, both public and pri- eliminating a lender’s potential initial losses from vate, to support the establishment or improve- default, guarantees incentivize creditors to over- ment of effective rural credit rating bureaus. come their risk aversion to financing agricultural Leveraging Climate Finance to Make Agriculture Part of the Solution 25 borrowers. Guarantees vary in nature and in opera- Guarantees, used carefully, have the potential tion, in the coverage they provide, and in the types to allow lenders to enter new markets and provide of investments that they secure. They can be par- financial services to clients who previously were ticularly useful for overcoming entry hurdles, such underserved. Some of the potential benefits for as supporting new financing models for rural small- smallholders and SMEs are: holder farmers and SMEs that are not considered creditworthy due to, among other problems, their •• Reduced collateral requirements (Hamp et al. perceived higher risk, little or no collateral, seasonal 2013); activities, and irregular cash flows. Guarantees can •• More customized financial products that better also be relevant when banks are reluctant to lend suit the seasonal need of farmers; due to uncollateralized loans that require significant •• More favorable loan conditions, such as lower reserves. interest rates; In other sectors, climate finance has already been •• Longer-term loans, which enable borrowers used to provide first-loss or partial-credit guar- to invest in, e.g., equipment and added-value antees to mitigate the perception that certain seg- infrastructure; ments are expected to have higher losses. Some FIs •• Longer repayment periods that enable borrowers have noted that credit lines are more effective than to finance agricultural investments and seasonal guarantees for motivating them to move into new activities; and markets because they provide the necessary capital •• More cost-effective delivery mechanisms to reach (often off-balance sheet) to enable them to invest farmers, because they are located in rural areas, (Box 3.4). where transaction costs are substantially higher Whether through risk-sharing guarantees or than in urban areas. credit lines, these types of mechanisms that incen- tivize local financial actors to deepen their sector Guarantees do not release a bank from its obli- lending often require additional technical assis- gation to fully understand and assess the risk of tance to build internal capacity within the local agricultural loans; it still has to assess the sustain- FIs. In these circumstances, technical assistance can ability of such lending and have the capacity to rate help train investment staff to assess both invest- loans appropriately. However, as suggested by KfW, ments further down the agriculture value chain and financiers could also use guarantees to capture agri- investments in segments that are not familiar to the culture-specific risks by carrying out a horizontal institution. segmentation of risk by “tranching” an agricultural Box 3.4.  Ethiopia Case Study: Farmers Access Finance Through Credit Guarantee Services While coffee production is a mainstay of Ethiopian agriculture, Of 42 Ethiopian cooperatives identified at the outset, 22 were Ethiopian coffee cooperatives are relatively weak and poorly man- selected to participate in the credit scheme, and templates and aged, and coffee sector borrowers are often limited by price vola- guidelines for preparing business plans were drafted so that tility and other fiscal constraints. The CFC/ICO/Rabobank Founda- these cooperatives could apply for loans to finance the coffee tion/Rabobank Rural Fund financing project aims to address these season. The guarantee scheme provided working capital loans challenges by helping cooperatives access finance in a sustain- amounting to over US$700,000 to 11 cooperatives, all of which able way, allowing them to improve coffee quality and raise the received their loans directly from the bank for the first time in their incomes of their producer members. history. As this phase was closing, the bank reported a 98 percent The project set up a credit guarantee scheme amounting to loan recovery rate. US$2.25 million to enable banks to use guarantees as an alterna- Having had no previous history of accessing loans, these coop- tive to traditional collateral. A risk-sharing agreement between eratives now feel empowered to access loans independently. Key the Rabobank Foundation and CFC covered half of any losses factors in this success were the capacity-building and education incurred through lending to farmers. The Rabo Rural Fund man- activities undertaken in Ethiopia since the start of the project, aged guarantees in the form of funds. Rabobank International and the guarantee scheme that provided support for lending to Advisory Services also provided technical assistance to banks to clients that historically would have been excluded due to lack of train cooperatives on financial literacy and corporate governance. collateral. 26 Making Climate Finance Work in Agriculture Figure 3.6.  Portfolio Tranching to Segment Risk Types Political risk and catastrophic events: The layer of infrequently ocurring risk with highest impact on overall portfolio quality Agro-specific risk: The layer of occasionally ocurring covariant risk with high impact on portfolio quality Principal credit risk: The basic layer of credit default risk due to frequently ocurring non-agro-specific reasons (i.e. illness of borrower, fire, theft etc.) Source: KfW. loan portfolio that identifies agro-specific risks more periods for agricultural loans to enable farmers to accurately than traditional vertical guarantees, which finance agricultural investments (KfW 2013). only cover credit risks (KfW 2014). Tranching a port- folio (see Figure 3.6) could offer an alternative to Insurance insurance products. Agricultural insurance allows smallholders and SMEs Potential Role of Climate Finance to transfer a risk of loss to a third party in exchange Climate finance could be used to support FIs through for a premium or a guaranteed and quantifiable grants and concessional lending to increase the small loss to prevent a large and possibly devastat- amount of agriculture lending to farmers and SMEs. ing loss. Some types of insurance deal specifically Two types of support could be provided. with agriculture-specific risks that cannot be miti- gated even where sound risk mitigation techniques Grants: (such as irrigation and pest management) have been •• Build FI capacity to segment their portfolios so effectively applied. These types, such as production, that they can benefit from innovative structured weather, and commodity price insurance, can cover guarantees to lend to the agriculture sector. crops, livestock, fisheries, and forestry, among oth- •• Support FIs in improving their risk manage- ers. They are especially useful for covering losses ment capacities to maximize the impact of the from adverse weather and other events beyond the guarantee and the sustainability of the long-term control of farmers, entitling the farmer to partial or outcome. full indemnification. Moreover, they can serve as col- lateral for agricultural loans and provide a safety net Concessional financing: for investments. •• Provide the (off-balance sheet) resources neces- Insurance based on PPPs tends to be more effec- sary to motivate FIs to move into new agriculture tive than purely private or purely state-organized markets. systems (KfW 2013) because it is often more prof- •• Encourage FIs to lend to the agriculture sector itable and more sustainable. However, for insurance by reducing the lender’s perception of the risk of to work effectively (either an index or an indem- agricultural loans. nity-based insurance product), there needs to be a •• Encourage FIs to provide more favorable loan supportive legal, institutional, and organizational terms and conditions for farmers, reduce collat- framework in which insurance and other risk man- eral requirements, and offer longer repayment agement tools can function efficiently. Leveraging Climate Finance to Make Agriculture Part of the Solution 27 Insurance also needs to be customized to the However, insurance as a financial product may developmental stage and structural differences face greater resistance from farmers than other forms (such as the revenue differences of large, medium- of financing, in part because in many countries, there sized, and small farms) of a given agricultural sector. is considerable distrust of insurance. Many farmers Moreover, it can be targeted to the level of both the are fearful that premiums paid will not result in ben- individual and the aggregate (especially in the case of efits when claims are made. In many places, whether weather-index-based insurance) where the basic risk insurance products become widely adopted depends can be absorbed by the aggregating body. This can on the product being tested, the risk-adjusted costs also apply to FIs, which can insure a certain segment of being affordable, and accessibility to payouts when of their portfolio at risk by transferring that risk to required. the third-party insurer. Furthermore, the financial viability of agricul- Insurance also has significant potential to help tural insurance products will depend heavily on farmers and financiers manage agriculture-specific the impacts of climate change, which for any pro- risks, although it tends to work better when bundled duction-related risk will increase the frequency and with other financial products as it becomes more severity of hazards, which will inevitably push up effective at protecting all parties—farmer, creditor, the costs of insurance. Insurance products could and off-taker behind the loan (IFC 2012). Insurance be more successful combined with other efforts to coverage for agriculture risks—especially climate- transform agriculture practices in light of climate related weather risks—is widely recognized as a change. Hence, agriculture insurance should accom- missing financial instrument in most markets (Box pany climate-smart investments for mitigating and 3.5). Where it is available, however, it can play a criti- adapting agriculture to climate change, with insur- cal role in enhancing the financial stability and cred- ance taking up the residual risk. itworthiness of farmers as a market segment. Unlike most risk-sharing mechanisms structured with FIs, Potential Role of Climate Finance: insurance can mitigate the risks of extreme events, Climate finance could be used to ensure the neces- such as flood or drought. Parametric insurance sary conditions to promote the development and use approaches in particular are seen to be valuable in of appropriate insurance mechanisms by providing helping farmers to manage shocks, particularly when grants and concessional financing. Two types of sup- climate-related weather events depress crop yields. port could be provided. Box 3.5.  Kenya Case Study: Input-linked Weather Insurance – Syngenta Foundation and UAP Insurance Pre-commercial growers often cannot easily afford and access vice, which substantially reduces transaction costs. Payouts are insurance products. In partnership with UAP Insurance, one of the calculated based on data from solar-powered local weather sta- leading insurance companies in Kenya and Uganda, the Syngenta tions, which regularly update rainfall quantities and the weather Foundation for Sustainable Agriculture aims to address this issue conditions near individual farms. by offering the simple and affordable weather insurance product Results from the 2009 season, when there was a severe “Kilimo Salama” (Kiswahili for ‘safe farming’). Supported by the drought, showed that through two weather stations the product Global Index Insurance Facility (GIIF) and agribusiness partners offered payouts to all 200 maize farmers that it covered, cover- such as Syngenta East Africa Limited and the fertilizer company ing 30–80 percent of their insured maize seeds. Syngenta paid MEA, the short message service-based insurance scheme has the premium in full. During the 2010 season, the product covered been scaled up across Kenya. 12,000 farmers through 25 additional weather stations, and Syn- Via a mobile phone application, smallholders buying agricul- genta paid half of the premium. That year, 1,200 of these farm- tural inputs from local agro-dealers are linked to the insurance ers received payouts for 10–50 percent of their insured inputs. In program. Simply scanning the barcode affixed to a product can set the following season, Syngenta launched “Kilimo Salama Plus,” up a contract between a farmer and UAP. Smallholders pay only which expands the insurable sum per farmer to the expected yield half the premium; Kilimo Salama’s agribusiness partners pay the value of a wider array of crops, including wheat, beans, potatoes, other half, which makes the insurance affordable for rural dwell- and sorghum. The product was also expanded to contract farming ers. In case of climate extremes, farmers are immediately com- arrangements for agribusinesses. pensated for yield losses through a mobile money transfer ser- 28 Making Climate Finance Work in Agriculture Grants: The VCF approach generally includes working •• Train insurer staff in how to design and deliver with individual farmers through farmers’ associa- agriculture coverage. tions, aggregators, and other forms of collaborative •• Support the collection of climate and weather enterprise, thereby enhancing farmers’ capacity to data and information on which to build farmer diversify, transfer agriculture-specific risks, and cre- user services (e.g., early warning systems) and ate economies of scale in market transactions, all of insurance products. which heighten the negotiating power and profit- •• Pilot ways to link financiers and insurance compa- ability of farmers. The risks and costs of delivery and nies, among others, with providers like HUGinsure monitoring are thus reduced, enhancing not only that can provide risk management and risk miti- lending but also access to a broader range of services, gation instruments for social impact investment. such as payments and insurance that were previously beyond the reach of producers and other value chain Concessional financing: actors. There are many examples of banks expanding •• Provide capital to insurers to design and offer lending to agricultural sectors by working with aggre- appropriate agriculture insurance products (such gators, who act as agents for the banks with their sup- as weather and crop) for farmers, aggregators, pliers. As a result farmers who had been financially SMEs, and FIs. excluded could receive pre-season financing on a scale •• Pilot new PPPs among meteorological, insurance, never before achieved, and often at a cost substantially and financial providers. below the rates offered by informal lenders (Box 3.6). •• Provide risk-sharing or other low-cost financing Moreover, this increase in financial services allows to help offset the risk-adjusted costs for consum- banks to take in more deposits, increase and diver- ers or other sectors of the market where the need sify their portfolios, and develop a long-term growth is significant but the ability to absorb the costs is strategy. low. •• Develop innovative business models that can Potential Role of Climate Finance provide risk management and risk mitigation Climate finance could support parties within the instruments for social impact investment inter- value chain by providing grants and concessional ventions (climate-smart investments in agricul- finance to create a conducive environment that pro- ture through new channels). motes the expansion and adoption of agriculture VCF. Three types of support could be provided. Agriculture Value Chain Finance Grants: Traditionally, financiers have been reluctant to lend •• Train staff to map out catchment areas and iden- to smallholders and agricultural SMEs due to the tify actual and potential value chains. high risk and transaction costs involved. However, •• Train staff to identify aggregators and farmers some of the risks can be managed effectively by that are integrated into value chains. using a value chain finance (VCF) approach. A •• Train staff to assess climate-smart criteria and VCF approach consists of providing financial prod- deliver VCF services that achieve positive climate ucts and services based on business relationships outcomes. between actors within the same value chain. This •• Pilot new partnerships to integrate farmers into section focuses specifically on the agriculture value new value chains. chain, in which FIs are the main source of financial products and services. The VCF approach encom- Concessional financing: passes a comprehensive assessment and understand- •• Pilot innovative ways, through climate-smart ing of the entire value chain, rather than a simple incubators, to aggregate farmers engaged in cli- credit risk assessment of the borrower, including the mate-smart practices. links between activities and value chain actors, their •• Pilot different VCF models that can integrate financing relationships and physical and informa- smallholder farmers outside of value chains or in tional flows, and the subsequent design of custom- loose value chains. ized financial products that meet the needs of the •• Pilot innovative ways to tighten loose value different actors within the value chain. chains through “new age” aggregators, who are Leveraging Climate Finance to Make Agriculture Part of the Solution 29 Box 3.6.  India Case Study: Value Chain Finance – HDFC Bank In India, most smallholder farmers still operate within loose bank products and insurance to the farmers within the value chain supply chains and are thus left alone in negotiating sales, and to other locals, thus earning more, which makes the model acquiring finance, and improving management techniques to more profitable. The bank keeps a close control on business cor- cope with climate change. In order for Indian smallholders to respondents through direct and remote supervision and training access technology and better manage production, market risks, to ensure service standards. Finally, an important benefit of this and climate risks, HDFC Bank introduced a Value Chain Finance platform is that the bank uses it to make it easier for customers to (VCF) model. access social transfers and government subsidies. HDFC Bank’s VCF model aims to address both the primary Results of this model have been very encouraging, with barriers to extending finance to smallholder farmers: risk and good control of both delinquencies and costs. HDFC has there- cost. Farmers tend to be near produce collection points, which fore been scaling up the model to reach the smallholder farm- creates economic density. Moreover, all transactions between ers who make up more than 75 percent of the rural population. farmers, aggregators, and off-takers are captured through bank Currently, the bank is increasing its digital/mobile transaction accounts, providing the bank with the credit history necessary to footprint within the ecosystem to keep making the model more lend to the farmers without the need of collateral security. The efficient and to develop new products; it is also conducting bank then identifies a lead farmer or local person to function as financial literacy programs in these villages. In the next phase the business correspondent, which reduces the cost of delivery of development HDFC will use third-party providers to deliver to the farmer community and creates a bond of trust between the value-added services to farmers to improve their productivity farmers and the bank. The business correspondent also sells other and sustainability. high entrepreneurial and emphasize behavioral changes in addition to the objectives set by more India Case Study: Warehouse Receipt Financing – Box 3.7.   traditional aggregators. HDFC Bank •• Design and pilot financial products and services that meet the needs of farmers engaged in value Small farmers often struggle to preserve their harvest in order to chains while ensuring the achievement of positive hold off selling until market prices and potential profits are high. climate outcomes. Warehouse receipt financing—the use of securely stored goods as loan collateral—can address this issue while also mitigating the risk to FI. Warehouse Receipts HDFC Bank, one of India’s leading banks (balance sheet: US$55 billion), offers a warehouse receipt loan facility where farm- Lack of hard collateral prevents farmers from being ers and small traders can receive loans starting from Rs. 1 Lakh able to access finance whilst financiers often both fail to (US$2,250) against storage of about 50 different commodities in assess risks adequately and seek to protect themselves one of over 3,500 approved private or state warehouses country- from agriculture-specific risks and thus potential loan wide. HDFC generally finances 65–75 percent of the receipt value and offers moderate interest rates of 8 to 10 percent. Farmers default. However, some financiers are starting to accept receive the loan as soon as they deliver the warehouse receipt. movable (soft) collateral from those smallholder farm- Since many warehouses require a minimum lot for stocking, indi- ers and agricultural SMEs that are either integrated into vidual small farmers usually have limited access, but they can par- value chains or already benefit from contract farming, ticipate by pooling their resources through a single representative which allows them to use a future crop as collateral. farmer. Of particular interest is the warehouse receipt, a In 2011 about 800 farmers participated, with trends indicating type of movable collateral by which farmers deposit that participation is on the rise. Profits for farmers range between their commodities in secure warehouses that issue 35 and 40 percent. HDFC also benefits from low risks and losses (1–2 percent) and from spending less on collateral management receipts in return. Financiers can then consider the and supervision, thus increasing its profit margins. Central to this deposited inventory as collateral. The acceptability of model’s success is the efficiency and high-quality management warehouse receipts requires a supportive legal and reg- of HDFC’s warehouse surveillance system, which includes well- ulatory environment and secure warehouses that are trained warehouse inspectors, collateral managers, weekly mark- well-maintained and insured if the receipts are to func- to market-valuations, and timely liquidation of stocks if there is a tion effectively. They work particularly well for farmers default. whose commodities are not perishable (Box 3.7). 30 Making Climate Finance Work in Agriculture This type of risk management mechanism has Climate-smart Advisory Services the potential to allow farmers not only to access finance through the provision of soft collateral but The lack of information for smallholders and SMEs also to manage specific risks, especially market risks. about weather events, effective agricultural prac- Through these mechanisms, farmers can store their tices and technologies, markets, and pricing, among commodities post-harvest and thus avoid losses, sell other subjects, substantially increases their expo- their commodities at the right time and with the sure to agriculture-specific risks and jeopardizes the right quality, etc. sustainability of their livelihoods. Agriculture advi- sory services, which provide information, skills, and Potential Role of Climate Finance technologies to farmers, have enormous potential to Climate finance could be used to help develop effec- reduce their exposure to risk and heighten their skills tive warehouse receipt schemes by providing grants by equipping them with the information and knowl- and concessional financing. Two types of support edge they need to adapt better to changing condi- could be provided. tions and to become more resilient. The rapid development of ICT technologies and Grants: the market penetration of mobile phones in devel- •• Design and pilot warehouse receipt schemes that oping countries present an excellent opportunity to take into account climate-change considerations. expand the provision of such services at a much lower •• Train FI staff in the use and management of ware- cost and more quickly. These services can provide house receipt programs that have climate-change farm-specific, weather, and market information to cli- considerations integrated into the design. ents through SMS messages so that they can improve •• Set up registries of movable assets such as ware- their agriculture management techniques, raise house receipts. their productivity, better adapt to climate change, and obtain accurate information about when to sell Concessional financing: their products and at what prices. Several examples •• Support the purchase and development of high- of mobile applications that provide this informa- quality warehouses that take into account cli- tion and store it in cloud-based systems are currently mate-change considerations. being piloted and appear to be successful (Box 3.8). •• Pilot and purchase insurance to cover the risks associated with warehousing. Potential Role of Climate Finance •• Help roll out warehouse receipt schemes to those Climate finance could be used to help create an farmers and SMEs that adopt climate-smart environment that promotes effective and affordable practices. climate-smart advisory services by providing grants Box 3.8.  Philippines Case Study: Climate-smart Rice Cultivation through Phone Apps Farmers rarely have easy access to extension services and planting dates, weather forecasts (obtained through partnerships other sources of information that can help them become more with meteorological services), and the answers to questions productive given the conditions of their specific situation. To about previous yields and management practices. The extension help connect farmers with local extension officers via technol- officer can send recommendations, which can be downloaded at ogy, in 2013 the International Rice Research Institute (IRRI) in no cost, to the farmer’s smart phone via SMS or to web-enabled collaboration with the Department of Agriculture of the Philip- computers via email. pines created a decision support tool called the Rice Crop Man- Through improved crop and nutrient management, RCM aims ager (RCM). to add 300 kg of un-milled rice to each crop per hectare per sea- The RCM is a cloud-based application that enables rice farm- son. This additional production would amount to an extra 20,000 ers to manage their fields more cost-effectively and thus sustain- metric tons of milled rice for each of the 100,000 hectares of rice ably increase their yields. The application allows agricultural cultivated. The RCM is currently being diffused across the Philip- extension staff to give farmers location-specific recommendations pines and has been embedded within the Climate Smart Agricul- on pest, weed, nutrient, and water management. The recommen- ture Advisory Service (CSAAS) of CCAFS, the research program on dations are based on a combination of historical climate data, Climate Change, Agriculture and Food Security. Leveraging Climate Finance to Make Agriculture Part of the Solution 31 and concessional financing. Two types of support reduce information asymmetry and the associated could be provided. lending risks, thus expanding access to capital for hun- dreds of millions of previously underserved people. Grants: Two main innovations that are already taking place •• Train the staff of service providers on delivering (Jamal et al. 2016) relate to the ability to collect and climate-smart advisory services. collate new data sources (“alternative data”), both dig- •• Increase awareness among farmers of the purpose ital and nondigital, and the ability to analyze and apply and the availability of climate-smart advisory this data through new methodologies (“data science”). services. These services analyze the digital footprint (including phone calls, text messages, Internet Concessional financing: browsing, use of social media, airtime top-ups, util- •• Pilot PPPs with meteorological, insurance, and ity payments, mobile money transactions) of mobile financial service providers and mobile network customers (from mobile phone usage, e-wallets, and operators. mobile phone platforms) and also analyze nondigital •• Set up and improve meteorological stations that data. The resulting “big” data are then used to assess collect climate change and weather data. credit risk, determine creditworthiness, and ulti- •• Develop a cloud-based pool of climate-smart mately provide loans. These services at the moment information on agriculture practices, technolo- are mostly directed to small short-term loans for gies, etc. that can be accessed by farmers and SMEs. younger tech-savvy customers in urban areas, •• Design and pilot new climate-smart advisory ser- although there are also some interesting examples of vices using ICTs. credit scoring models that use “alternative” data to •• Support new entrants in the market to increase com- target agricultural borrowers, such as those of Gro petition and the supply of products and services. Ventures, Farm Drive, and the Grameen Foundation; firms like EFL and Arifu are also piloting programs to explore their relevance to farmers. Big Data and Data Science These types of innovation open a path to further Currently, there are promising innovations combining explore the potential of such services to reduce the the use of mobile technologies, such as big data and risk and the cost of assessing the creditworthiness data science, that have the potential to dramatically of smallholders (Box 3.9). In order to do so, the Box 3.9.  Big Data Case Study: Reaching Smallholders with Alternative Credit Assessments In order to access financial services, clients usually need to be Another case is Lenddo, which operates in the Philippines, Colom- documented and show a formal credit history. As a result, small- bia, Mexico, and India and uses social media activity, networks, and holders and the rising middle class in emerging markets often social reputation to assess the creditworthiness of costumers. It also cannot get funding. This dynamic is changing, however, because extends loans either directly or in partnership with other lenders. In credits are increasingly based on using advanced data analytics Colombia, it was found that about 70 percent of those who borrowed to assess consumer credit risks. “Big Data, Small Credit” (BDSC) from Lenddo were willing to share with it information on their social scoring schemes thus often rely on nontraditional data sources, media activity and web-browsing history to improve their chances such as social media and mobile call records. Since it can sig- of getting a larger loan, or indeed any loan. The founders of Lenddo nificantly lower the costs of scoring, BDSC has great potential for estimate that currently about 1.2 billion other adults with digital the financial inclusion of otherwise excluded segments, and for footprints do not have access to formal credit. delivering better and cheaper financial services. The application of BDSC is still at its infancy, and many start- An example is the big data firm Cignifi, which creates algo- up companies are experimenting with markets, consumer seg- rithms from records of prepaid mobile phones (e.g., SMS and ments, and models. Because the applied algorithms are very new call frequency, caller duration and network, payment patterns) to compared to the long-tested credit-scoring methodologies used determine client credit scores and to target tailor-made products by traditional credit bureaus, scoring accuracy may still need to to a broader clientele. This algorithm-based ability to assess the be adjusted, and new competitive modes and partnerships may creditworthiness of previously unbanked consumers comes at a arise. The hope is that BDCS will not only deliver better credit to significantly lower cost than the conventional method of deter- emerging consumers but also successfully lower transaction and mining creditworthiness. service costs for FIs and private businesses alike. 32 Making Climate Finance Work in Agriculture following three areas will need further attention to changes by designing more cost-effective and inno- facilitate the development of models that address vative set-ups, processes, partnerships, and delivery the particular needs of smallholder farmers and mechanisms. Such changes would allow them to SMEs (Jamal et al. 2016): keep the costs per unit of capital lent sufficiently low to generate enough margin. This section examines •• More collaboration with nontraditional groups several cost-effective models that, when used effec- like technical assistance providers, who may tively and under the right market conditions, show already have large data sets on the identities, promising results for expanding financial services to behaviors, characteristics, and assets of farmers; smallholders and agricultural SMEs. •• More digitalization of data from government sources, extension workers, and those in agricul- Branchless Banking ture value chains, among others; and •• More context-appropriate investment to allow Branchless banking refers to the provision of finan- innovations to conduct longer pilot programs. cial services outside the conventional network of FI branch locations. The equipment (such as ATMs Potential Role of Climate Finance and trucks) may be owned by the financier or by a Climate finance could be used to facilitate emergence partner (such as bank employees, partner employ- of the conditions necessary to further develop big ees, and agents). Branchless banking relies on ICT data and data science business models relevant to the to conduct financial transactions through points-of- agriculture sector through grants and concessional sale (POS) or mobile phones. This delivery model financing. Two types of support could be provided. has the potential to substantially reduce transaction costs while increasing access to financial services for Grants: farmers in rural and other underserved areas where •• Collect data from traditional and nontraditional setting up a branch would not be financially feasible actors in agriculture finance. (Box 3.10). Within this type of delivery model, PPPs •• Support firms that wish to digitize and analyze big could be essential in enabling financiers to explore data for use in credit-scoring models. alternative, innovative, and cost-effective business •• Incorporate climate-smart principles in credit- models that can guarantee the delivery of secure and scoring models where feasible. efficient financial services. Among options for this •• Train FI staff in the use of such technologies type of model that have been used in developing to assess the creditworthiness of agricultural countries are post offices, branches of mobile net- borrowers. work operators (MNOs), and value chain actors. •• Design and pilot big data and data science models To maximize the potential of this delivery model, that are suitable for farmers. improvements are needed in, among other areas, the •• Adapt the investment environment to allow for applicable regulations, the number of service points, longer pilots that have the potential for positive the simplification of processes to open accounts, and results for farmers. the authorization of more providers to offer pay- •• Support financial institutions to adopt such ment and e-services. credit-scoring models. Potential Role of Climate Finance Concessional financing: Climate finance could be used to support those inter- •• Provide capital to new market entrants to expand ested in creating the environment and infrastructure alternative business models. necessary to promote branchless banking services by providing grants and concessional financing. Three types of support could be provided. Mechanisms to Reduce Transaction Costs One major constraint that financiers face in deliv- Grants: ering financial services to smallholder farmers and •• Support adoption of regulations that promote the SMEs is the high transaction costs involved in pro- establishment and growth of branchless banking. viding such services. Overcoming the constraints •• Organize and strengthen agent networks and will require FIs to make substantial organizational their management. Leveraging Climate Finance to Make Agriculture Part of the Solution 33 Box 3.10.  Pakistan Case Study: Branchless Banking – United Bank Ltd. In Pakistan, only 10 percent of the adult population has bank accounts Through Omni and its extensive network of agents, clients can at formal financial institutions, and few of the account owners are in now easily and cheaply qualify for microloans, transfer money, rural areas. To improve smallholder access to banks in rural Pakistan, and make payments via mobile phone or full-service kiosks. Both in April 2010 United Bank Ltd. (UBL) launched its “Omni” branch- clients and UBL also benefit from lower transaction costs, which less banking program. With more than three million clients and over otherwise limit the ability of clients in rural areas to access finan- 1,200 branches, UBL is Pakistan’s second-largest private bank. cial services. UBL also has created links with microfinance institu- For this program UBL has installed full-service kiosks, “Omni tions to accept loan repayments. Durkaans,” at retail partner locations in over 500 cities and towns. Over the next five years, UBL expects 15–20 million people to At these locations farmers who set up an UBL account are linked benefit from these services. An additional benefit is that UBL has to an Omni mobile number. Account holders must maintain a also partnered with nongovernmental and governmental bodies minimum balance of Rs 100 (US$1.15), and can choose between to facilitate payments for support and relief programs, benefiting weekly, monthly, annual, or pay-as-you-go options. Clients can millions of Pakistanis. Through the Omni kiosks, two million Paki- also receive a debit card and make transfers at one of 500 ATM stanis have received payment from flood relief and income sup- network locations. Clients without mobile phones can pay bills port programs and the World Food Programme. or transfer money through an over-the-counter transfer service, which has become very popular. •• Train agents as climate-smart investment brokers affordable financial services while significantly reduc- so that they can identify borrowers engaged in cli- ing FI transaction costs. FIs and MNOs usually offer mate-smart practices and link them to creditors. mobile access that can be used for a wide range of ser- •• Design and pilot innovations to overcome opera- vices, such as loans, savings, domestic transfers, and tional constraints (e.g., agent liquidity, a high insurance. Such services can be accessed through a number of inactive members). variety of channels, such as those linked to electronic •• Identify partners and train staff on delivering accounts (wallets) and over-the-counter (OCT) trans- branchless banking services. actions that do not require clients to have an account. These types of services are already present in 93 Concessional financing: countries, offering a total of 271 services (GSMA •• Design and pilot new delivery models based on 2015). It also appears that there is still substantial ICT use. demand for mobile financial services, which showed •• Purchase the necessary equipment and construct a 31 percent increase in registered accounts (to 411 adequate infrastructure (branches, ATMs, POS, million people) in December 2015 (GSMA 2015). The etc.). demand represents a major opportunity to further •• Provide financial support to new market entrants develop enabling environments, a wider portfolio of that demonstrate innovative business models, services that can achieve greater market uptake, and products, or delivery channels. the engagement of inactive members of financial ser- vices so that more farmers can be financially included. A combination of grants and concessional financing: Moreover, mobile financial services have great •• Pilot and scale up PPPs with institutions and potential to link farmers who were previously finan- organizations interested in providing finan- cially excluded to bankers and allow FIs to mobilize cial products and services to farmers who have large amounts of deposits, which could then be used adopted climate-smart interventions. to lend to farmers, provide a source of digital data and of credit/financial transactions history, and be used as collateral (Box 3.11). Mobile Financial Services Given the skyrocketing market penetration of mobile Potential Role of Climate Finance phones and the increasing competition of MNOs in Climate finance could be used to help enable the developing countries, providing financial services conditions necessary to promote development via mobile devices has enormous potential to deliver and improvement of mobile financial services by 34 Making Climate Finance Work in Agriculture Box 3.11  Kenya Case Study: Mobile Banking – M-PESA and M-KESHO Low-income populations, especially those living in rural areas, M-Pesa accounts together with other financing tools to establish often cannot easily access financial services and so do not have secondary collateral sources through an integrated and farmer- a secure or affordable way to manage and store money at for- focused approach. mal FIs. Safaricom, Kenya’s largest mobile service provider, has M-Pesa is currently used by over 70 percent of Kenyan adults, partnered with the Commercial Bank of Africa and Kenya’s Equity and an average of 150 million Ksh (US$1.96 million) flows through Bank to launch a branchless and agent-network-based mobile M-Pesa every day, mostly in small amounts that average just over phone-based service, “M-Pesa,” that is helping customers to 1,500 Ksh (US$20). While one of its main functions is to facilitate access financial services and manage and store money. low-cost money transfer, remittances to rural areas in particular, M-Pesa offers clients a straightforward and affordable way it is also being used increasingly to accrue savings. It has been to transfer money, send remittances to rural areas, and pay bills. found that Kenyans with M-Pesa accounts are 32 percent more Client accounts are held in a trust fund at the Commercial Bank, likely to report having savings than those without accounts. In which facilitates formal savings across socioeconomic divides recent years, M-Pesa has expanded to South Africa, Afghanistan, while keeping transaction costs low. Lenders may also use India, and Eastern Europe. providing grants and concessional financing. Two •• Set up a clear and effective agricultural lending types of support could be provided. strategy; •• Put in place policies, systems, processes, and Grants: operational manuals to guide agricultural •• Train staff in how to use mobile technologies to lending; deliver financial services. •• Identify the mechanisms necessary to assess, man- •• Conduct sensitization campaigns to increase the age, and quantify agriculture- and climate- spe- awareness of farmers about mobile financial ser- cific risks; and vices, not only to increase adoption rates but also •• Identify opportunities to grow and expand agri- to promote active use. cultural lending and effectively manage and mon- itor their agricultural lending portfolios. Concessional financing: •• Support the development of a mobile money Potential Role of Climate Finance ecosystem. Climate finance could be used to help FIs and oth- •• Pilot and develop PPPs with entities interested ers to create the conditions necessary to promote in extending mobile financial services to bor- the provision of effective agriculture financial prod- rowers who have embarked on climate-smart ucts and services by providing grants structured interventions. around meeting milestones and targets or paid when •• Design and pilot new mobile products and ser- results are achieved. Two types of support could be vices that can reach underserved rural farm- provided. ers engaged in climate-smart interventions and increase market uptake. Grants: •• Support FIs integrating climate-smart guidelines Technical Assistance to Increase into their policies and operations, so that they can Investments in Agriculture be mainstreamed through their lending. •• Map out market opportunities to expand FI agri- Technical Assistance to Lenders culture finance portfolios. •• Pilot and engage in PPPs to leverage knowledge Development of Agriculture Finance Capacities and capacities of government and other institu- To build an effective and sustainable portfolio of tions in agriculture lending practices, especially financial products and services for agriculture, FIs those related to climate-smart practices. need to build the institutional capacity necessary to •• Put in place monitoring and evaluation tools to enable their institutions to effectively serve the agri- assess the impact of the agriculture lending port- culture sector. For instance, they could: folio in terms of climate relevance. Leveraging Climate Finance to Make Agriculture Part of the Solution 35 Concessional financing: agricultural experts tend to come up with overly com- •• Support the establishment of dedicated and spe- plex financial products and also may face periods of cialized agriculture lending departments where low productivity, given the seasonality of agricultural necessary. lending (KfW 2013). Moreover, lessons drawn from •• Design structured risk management frameworks the World Bank AgriFin program show that peer-to and tools to help mitigate agriculture- specific peer training (for example, bankers who have exten- risks so that they can lend to borrowers commit- sive experience working in agriculture lending train- ted to climate-smart practices. ing other bankers eager to enter that segment of the •• Help FIs to qualify for concessional financing market) tends to be significantly more effective than (debt, guarantees, and possibly equity) from training provided by development agencies, govern- investment incubators. ment bodies, or development consulting firms. Training staff on climate-smart interventions and Building the Capacity of Agriculture Finance Staff the benefits of farmers adopting certain climate- smart practices and technologies can make it easier All the interventions and financial instruments for bank staff to understand the capacity of farm- suggested above will only be effective in providing ers to reduce production risks and thereby increase sufficient and adequate finance to the agriculture their productivity, build resilience, and better adapt sector if technical assistance is provided to FIs to to climate change, which in turn could improve their help them understand and build capacity to design creditworthiness. This could have a positive impact and ultimately use the instruments and interventions on reducing the perception of agriculture in general, efficiently. and of farmers in particular, as high credit risks and Hence, a qualified and specialized lending team ultimately expanding the size and quality of the agri- will be crucial if FIs are to effectively provide agricul- culture-lending portfolio (Box 3.12). ture financial services. Such specialized teams would require staff that thoroughly understand agriculture Potential Role of Climate Finance and the economics of farming and have solid banking Climate finance could be used to help build the experience and robust credit risk assessment capaci- capacity of FI staff to provide effective finance ser- ties. Providing agricultural training to existing lend- vices to agriculture by providing grants structured ing staff can be highly cost-effective because they lend around specified milestones or payment by results. to all sectors throughout the year, whereas specialized Different types of support could be provided. Cambodia Case Study: Building Agricultural Lending Skills – Amret Microfinance Institution and the Box 3.12.   World Bank  ne difficulty many financial institutions face when lending to O rice—to educate staff about these commodities and the skills and any new sector is finding and training staff so that they have a equipment required to produce and market them. solid understanding of the actors, dynamics, and general work- To respond to growing farmer demand for larger loans, Amret ings of that sector. A partnership between the World Bank Agri- designed a specialized, cash-flow-based AgriFin loan product. Fin program and Amret Microfinance Institution, which recently Loan officers trained in the AgriFin cash-flow-based lending meth- established a new agricultural lending unit, demonstrates that a odology disburse these loans. The average agricultural loan now specialized agricultural lending unit can help grow a successful amounts to about US$6,000, over four times the size of the aver- agricultural loan portfolio. age microloan previously offered to farmers (US$1,300). As of In consultation with AgriFin, Amret filled positions in the new October 2014, AgriFin loans amounted to US$11.6 million, equal agricultural unit with internally recruited personnel who were to four percent of Amret’s total loan portfolio. then trained in agriculture. Amret also appointed two perma- Amret is now seeing higher demand for agricultural lending nent trainers to coach branch lending staff during the pilot and from a new market of farmers whose financial needs are growing. rollout phases on how to lend to agricultural clients and how to Putting in place a specialized agriculture unit was a major factor apply AMRET policies and procedures to agricultural lending. To in this growth. As a result, Amret is now considering mobile tell- supplement the training, Amret developed six agricultural sector ers as a cost-effective way to expand and scale up services to cards—for duck, pepper, cassava, rubber, and wet and dry season agricultural clients. 36 Making Climate Finance Work in Agriculture Grants: •• Support the work of FIs in designing and pilot- •• Train FI staff on agriculture finance, assessment ing customized products and services that better of agriculture credit risk, climate-smart invest- address the needs of borrowers engaging in cli- ments in agriculture, etc. mate-smart practices. •• Support international exchange visits by FI staff •• Train staff to deliver customized and affordable to learn what other institutions are doing, so that financial product and services. they can replicate best practices. •• Help FI staff to identify reliable brokers that can Concessional financing: provide a sufficient and attractive portfolio of cli- •• Help FIs to establish partnerships (PPPs or private mate-smart interventions, thus reducing risks and partnerships) with MNOs, insurance providers, transaction costs. suppliers, etc. so that they can offer more compre- hensive products and delivery mechanisms. Customizing Agriculture Financial Products and •• Encourage FIs to roll out customized products Services and services that better address the needs of bor- rowers engaged in climate-smart practices. A clear diagnostic is critical at the outset in order to •• Support FIs that are rolling out climate-smart identify challenges that must be tackled as well as cli- financial products and services. ent needs. Such a diagnostic can identify the tools and interventions most appropriate for a given case. Building Borrower Capacity In nearly all cases, a range of tools will be needed due to the multifaceted dimensions of the barriers to It is estimated (Dalberg 2014) that in 2011 low- and lending that must be overcome. Segmenting farmers middle-income countries spent US$191 billion on to identify their financial needs is vital, because farm- developing agriculture but only US$8.4 billion was ers are heterogeneous and have different needs. It invested in technical assistance for farmers (US$7 is thus important to identify sub-segments of the billion by governments, US$1.1 billion by interna- farming population and assess their needs and con- tional donors, and US$0.27 billion by corporations). straints before designing and customizing specific Yet smallholder farmers and SMEs could greatly ben- solutions and products. For example, in one location, efit from building their capacity and skills related smallholders may primarily need access to working to farm management, climate-smart practices and capital, payments, and remittance services, whereas technologies, and agriculture risk management— larger SMEs may prefer access to longer-term credit skills that can help them to become more produc- lines and leasing services to acquire machinery and tive, build resilience, and better manage the adverse make productive investments. effects of weather events and market and price changes. Enhanced knowledge, skills, and risk-shar- Potential Role of Climate Finance ing mechanisms will also equip them to better adapt Climate finance could be used to enable FIs to meet to and mitigate the impacts of climate change. the conditions necessary to build a portfolio of cus- Moreover, an often-overlooked requirement for tomized and affordable financial products and ser- expanding financing to agriculture is to provide vices by providing grants and concessional financing. potential borrowers with the skills they need to access Two types of support could be provided. loans and financial services. While larger enterprises have audited accounts and financially aware staff, Grants: SMEs often do not have the requisite financial docu- •• Support FIs as they conduct diagnostic studies ments or staff who can prepare credible loan appli- and map out the needs of and impediments for cations. Smallholder farmers similarly are not used farmers in general and those engaged in climate- to formally accessing credit and quite often they also smart practices in particular. lack financial management skills. Evidence from a •• Support FIs in integrating climate-smart princi- variety of programs has demonstrated how much ples into their portfolios of products and services. impact training borrowers can have. Failure to con- •• Conduct research on effective and affordable sider borrower capacity when designing agricultural innovations related to credit assessment, financial finance programs may at times result in capable FIs products, and delivery mechanisms. failing to find credible borrowers. Leveraging Climate Finance to Make Agriculture Part of the Solution 37 While often the barriers to increasing agriculture climate-smart practices to help them under- finance are attributed to the supply side, there are also stand the behavioral, technological, and practice significant barriers on the demand side, especially changes needed to become more productive while where food crops and less-organized value chains adapting to climate change. are concerned—and these are where the majority of •• Build up the skill base of farmers, either directly smallholder farmers are concentrated. There are a or through aggregators, to help them dismantle number of reasons for this, such as a lack of knowl- barriers that block demand for additional finance. edge about how financial systems work, insufficient •• Roll out training to farmers, directly or through trust in and understanding of the services available, aggregators, on, among other topics, business, and little capacity to generate enough revenue to financial, and management skills. repay obligations or make investments. Moreover, •• Train aggregators on risk management, context- adoption of climate-smart interventions is likely to specific climate-smart practices, and business and require additional skills and capacities and upfront financial skills. investments in new technologies and practices to •• Link farmers, SMEs, and aggregators to organiza- facilitate the transition to low-carbon and more tions that provide brokering services that connect climate-resilient agricultural practices. Smallholder them to FIs. farmers and SMEs therefore need technical assistance to help them build awareness and better understand the behavioral, technological, and practice changes Notes needed to mainstream climate smartness into their 1. Concessional financing could refer to debt, equity, agriculture interventions, and also to build the skills guarantees, etc. 2. These are principles that promote climate-smart needed to access finance to deal with climate change. investments in the agriculture sector to heighten agricul- tural productivity and adaptation to climate change while Potential Role of Climate Finance reducing emissions intensity. Climate finance grants could be used to help farm- 3. The Sustainable Banking Network consists of central ers build their capacities and expand their skill base banks in emerging markets that have issued environmental to effectively use financial resources for agricultural and social guidelines that should apply to lending to vari- ous sectors, including agriculture. activities while adapting to climate change and 4. This could be done by identifying a set of metrics reducing emissions. Support could be provided to: that help measure the climate-smartness of an agricultural activity, project, or investment. •• Design training materials on, e.g., risk manage- 5. The Global Impact Investing Network (GIIN) in ment, climate-smart interventions (especially for particular has effective monitoring and evaluation tools. 6. These guidelines could be specifically targeted to adapting to and mitigating climate change), and each entity interested in realizing climate-smart invest- business and financial skills. ments in agriculture (climate funds, bilateral and multilat- •• Directly or through aggregators, build the capac- eral organizations, FIs, private companies, and impact and ity of smallholder farmers and SMEs to adopt institutional investors, among others). Chapter 4 CONCLUSION AND WAY FORWARD Clearly, agriculture is not only extremely vulnerable Program is designing green bonds to raise capital in to climate change but is also a significant contributor international markets, which will then be channeled to it, accounting for 19–29 percent of total anthro- through local FIs. To raise additional capital, the pogenic GHG emissions (Vermeulen et al. 2012). Althelia Climate Fund is offering market-rate con- Moreover, due among other factors to the growing servation investment products to individual private global population and changing diets, by 2050 the investors. All of these examples are also combining sector will need to produce at least 50 percent more these financial instruments and mechanisms with a food to feed nine billion people. It is estimated that variety of other financial products, such as guaran- at least US$80 billion annually will be needed to tees and grants for technical assistance. finance that increase in food demand; most of the There are many other promising options like funding is expected to come from the private sector those described in the case studies that can be rep- (WB 2015). licated. To facilitate the rapid advancement and In this situation climate finance can be a major scale-up of such innovations, concrete action must catalyst for providing and leveraging additional be taken to enhance the multiplier effect that climate sources of finance, both public and private, and for finance can have in supporting the transformation to supporting the emergence of more effective and effi- low-emissions and climate-resilient agricultural sys- cient environments that allow financing to flow to tems. The following four actions could facilitate this smallholder farmers and SMEs to fund investments process: in low-emission, climate-resilient agriculture. To ramp up agricultural production on the scale •• Improve and disseminate financial knowledge: needed, it will be essential to establish PPPs that It is essential to identify the most efficient ways bring together donors, governments, climate funds, to support the transformation to low-emissions, development and international FIs, civil society, pri- climate-resilient agricultural production. In order vate and institutional investors, and others from the to do so, it will be necessary to design innovative agriculture, climate, and financial sectors. It will also financial mechanisms, investment vehicles, and be necessary to continue to design and pilot inno- financial instruments that can provide more tai- vative financial mechanisms and instruments that lored and comprehensive solutions to the specific can accommodate the different risk-return profile challenges of climate change that now confront of each of the stakeholders involved. Bundling sev- agriculture. It will be critical to identify new ways eral financial instruments and interventions can to use these to leverage additional capital from help to produce more holistic and comprehensive public and private sources and find more effec- solutions. For instance, Finance in Motion is using tive avenues to direct it to smallholder farmers layered capital structures to meet the risk appetite and SMEs. It will be equally important to allocate of each of its investors and the social, economic, and sufficient resources to assume certain levels of risk financial returns each expects. The Global Canopy and to pilot and bundle innovative mechanisms 40 Making Climate Finance Work in Agriculture so that a wide range of financial approaches can agriculture, climate, and financial sectors, it will be tested and if successful scaled up. What will be crucial to create spaces to convene all stake- also be necessary will be to find effective commu- holders and promote dialogue. To that end, spaces nication channels to disseminate such financial like the Conference of Parties to the UNFCCC knowledge and information to stakeholders so as can act as a catalyst to bring all parties together, to heighten the capacity of all involved to ensure bridge knowledge and information gaps, and fos- that their climate-smart investments are effective. ter mutual understanding, dialogue, and collabo- •• Bridge gaps and identify opportunities: Given ration. International and regional networks like the number of sectors (agriculture, climate, and the GACSA, Global Impact Investing Network finance) and parties (government, donors, civil (GIIN), the Global Innovation Lab for Climate society, financial institutions, private companies, Finance, and the OECD Partnership for Climate and private investors, among others) that sup- Finance and Development, among many others, port low-emissions, climate-resilient agricultural can also encourage stakeholders to discuss current systems, reaching common ground may not be challenges and opportunities and identify innova- easy. For each sector and stakeholder there are tive financial solutions and new ways of collabo- different backgrounds, expertise, and objectives ration that can generate win-win situations for all and therefore often different “languages” and parties. Such spaces need to bring in stakehold- approaches. The lack of agreement among stake- ers from all sectors, from institutional and impact holders on how best to promote climate-smart investors through climate donors and govern- investments in the agricultural sector can under- ments, from private companies and FIs to SMEs mine the potential for addressing the challenges and smallholder farmers. in a coordinated, effective, and timely manner. It •• Draft action plans: To transition to low-emissions, is therefore essential to effectively and consistently climate-resilient agriculture, stakeholders from promote interaction between stakeholders so that different sectors will need to identify and agree on all can better understand each other’s character- specific next steps, so that concrete action plans istics, expertise, strengths, and objectives. This can be drawn up. 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